[Senate Hearing 111-53]
[From the U.S. Government Publishing Office]



                                                         S. Hrg. 111-53


        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2009

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

                                HEARING

                               before the

                              COMMITTEE ON
                   BANKING,HOUSING,AND URBAN AFFAIRS
                          UNITED STATES SENATE

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                                   ON

      OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- 
       ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978

                               __________

                           FEBRUARY 24, 2009

                               __________

  Printed for the use of the Committee on Banking, Housing, and Urban 
                                Affairs


      Available at: http: //www.access.gpo.gov /congress /senate/
                            senate05sh.html



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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

               CHRISTOPHER J. DODD, Connecticut, Chairman

TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          MEL MARTINEZ, Florida
DANIEL K. AKAKA, Hawaii              BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  JIM DeMINT, South Carolina
JON TESTER, Montana                  DAVID VITTER, Louisiana
HERB KOHL, Wisconsin                 MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             KAY BAILEY HUTCHISON, Texas
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado

                 Colin McGinnis, Acting Staff Director
              William D. Duhnke, Republican Staff Director
                       Amy Friend, Chief Counsel
                      Aaron Klein, Chief Economist
               Jonathan Miller, Professional Staff Member
                  Drew Colbert, Legislative Assistant
                   Lisa Frumin, Legislative Assistant
                 Peggy Kuhn, Republican Chief Economist
                    Andrew Olmem, Republican Counsel
                   Hester Peirce, Republican Counsel
                    Jim Johnson, Republican Counsel
          Mark Calabria, Republican Professional Staff Member
                       Dawn Ratliff, Chief Clerk
                      Devin Hartley, Hearing Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor

                                  (ii)














                            C O N T E N T S

                              ----------                              

                       TUESDAY, FEBRUARY 24, 2009

                                                                   Page

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

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     4
    Senator Johnson
        Prepared statement.......................................    62

                                WITNESS

Ben S. Bernanke, Chairman, Board of Governors of the Federal 
  Reserve System.................................................     5
    Prepared statement...........................................    62
    Response to written questions of:
        Senator Shelby...........................................    66
        Senator Johnson..........................................    72
        Senator Bennett..........................................    78
        Senator Tester...........................................    80
        Senator Crapo............................................    81

              Additional Material Supplied for the Record

Monetary Policy Report to the Congress dated February 24, 2009...    88

                                 (iii)

 
        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2009

                              ----------                              


                       TUESDAY, FEBRUARY 24, 2009

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:11 a.m., in room SH-216, Hart 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. Mr. Chairman, welcome. I hope that was 
instructive for you, Mr. Chairman.
    [Laughter.]
    Chairman Dodd. I am sure the Federal Reserve operates in a 
similar pattern as we do here on the Banking Committee. Do you 
get as much luck as the Chairman as I just did on that?
    Well, let me tell you how we will proceed here this 
morning, and we welcome you, Mr. Chairman, to the Committee. We 
have got a good turnout of our Members here for all the obvious 
reasons. When the Chairman of the Federal Reserve comes before 
our Committee, it is obviously of deep interest to the country, 
and we welcome you here this morning. I will take a few minutes 
for some opening comments, turn to Senator Shelby for any 
opening comments he may have, and then we will go right to you, 
Mr. Chairman, for your statement this morning, and we will try 
and follow the 5-minute rule so that everybody gets a chance to 
raise questions with you. And if we need a second round, we 
will do so. The record will stay open for a few days to submit 
questions, and any and all statements, documents, and other 
materials that my colleagues and others feel would be important 
to include in the record will be considered included at this 
moment, without objection.
    Well, Chairman Bernanke, we welcome you to the Committee to 
present the Fed's semiannual monetary policy report to the U.S. 
Congress. We meet obviously at a very important moment for our 
country, with our Nation in the midst of the worst economic 
crisis in generations. Since the end of World War II, America's 
business cycles have oscillated between periods of growth and 
rising inflation, with the Fed raising interest rates to slow 
the economy, creating a recession, which then caused inflation 
to slow. The Fed then typically lowered interest rates, 
restarting the Nation's economy again. And while the Fed 
manages our recessions, our economic recoveries have typically 
been led by the housing and automobile sectors, which are 
highly sensitive to interest rates.
    In the past, the typical American worker saved during the 
good times for rainy days, and when recession hit, they may 
have been laid off. But once the recession receded, they not 
only had some savings hopefully stored up, but also a 
reasonably good chance of getting their jobs back or finding 
new employment.
    This time, however, Mr. Chairman, our housing and auto 
sectors are leading us not out of recession but into it in many 
ways. This time our recession is being caused not by rising 
interest rates but, rather, a massive credit crunch, resulting 
from years of reckless spending and, as the Banking Committee 
has uncovered during the 80 hearings and meetings in the last 
Congress, regulatory neglect as well. Such neglect allowed for 
and even encouraged a problem that began in the subprime 
mortgage market to spread throughout our Nation and the entire 
global financial system like a cancer.
    This time, nearly half the jobs we have lost are not likely 
to come back, we are told, and that is why the American 
Recovery and Reinvestment Act is so essential. This time, the 
American people entered this recession with a negative personal 
savings rate and a false sense of confidence that we can count 
on the value of our homes and stocks to go up forever.
    In fact, Mr. Chairman, I read with great interest that your 
own boyhood home recently went into foreclosure. I am saddened 
by that, as I am sure you are. Most recently, that home was 
owned by a soldier in the South Carolina Army National Guard, 
who reportedly volunteered to go on active duty during wartime 
in order to try and save his home and your former home.
    Mr. Chairman, I do not suggest that you are to blame for 
any of this. Quite the contrary. I happen to commend your 
conduct of monetary policy during your tenure. Last year, you 
began to cut interest rates in the face of opposition from some 
regional bank presidencies at the Fed. You followed through on 
your commitment that you made, a meeting which I will never, 
ever forget in August of 2007, when you were in my office with 
Hank Paulson. And I will never forget the words you spoke to me 
that day when asked what we could about the problems, and you 
said at that time you would use all the tools at your disposal 
to attack the problems in the global financial market. And I 
commended you for those comments then, and your efforts, 
through aggressive and often innovative monetary policy.
    You have worked creatively to adapt the Fed to handle the 
greatest financial market crisis in any of our lifetimes. If, 
as it is said, those who do not study history are doomed to 
repeat its mistakes, I am relieved we have one of the foremost 
scholars of the Great Depression at the helm of the Fed at this 
moment.
    But for all the successes the Fed has had in carrying out 
its core mission--monetary policy--its regulation and consumer 
protection missions have been abject failures, in my view. And 
while many of these failures predate your arrival, they cannot 
be ignored.
    When I am approached by a constituent in New London, 
Connecticut, for instance, who was outraged that some of these 
banks were allowed to grow into behemoths and given a clean 
bill of health, only to turn around months later on the verge 
of bankruptcy, asking for billions of dollars in taxpayer 
funding, I am reminded of the shortcomings in the Fed's 
regulation of bank holding companies.
    When a family in Bridgeport, Connecticut, with their 5,000 
foreclosures in that one city in my home State pending, who 
have lost everything ask me where the cops were on the beat, 
where were they to stop the abusive predatory mortgages from 
being written, I am reminded of the Fed's failure to implement 
the law Congress passed in 1994 to protect consumers and 
regulate mortgage lending practices.
    When I learn a direct marketing business in greater 
Hartford has to close its doors, not because they missed a 
payment to their bank but because the bank is having capital 
problems, I cannot help but remember your predecessor's 
fondness for ``regulatory competition,'' as he called it, for 
actually encouraging bank regulators to compete with one 
another to see who could provide the most effective regulation 
of our banks, but apparently at the least.
    As a result, today countless banks are left with 
dangerously low cash reserves and a massive buildup of 
leverage, which have created a veritable boomerang of debt that 
has now snapped back, ensnaring countless honest small 
businesses in the process.
    Finally, when I am asked how our Government could have 
allowed these toxic financial products to proliferate, products 
that served to dilute the appearance of risk rather than the 
risk itself, I remember the Federal Reserve's mantra of 
financial innovation and its leaders' repeated warnings against 
any additional Government regulation of any kind. I remember 
very, very clearly the mood in January of 2007 when I became 
Chairman of this Committee and the mantra--the mantra in those 
months was, ``Deregulate, fast, before everyone runs to 
London.''
    Mr. Chairman, you have an extraordinarily difficult task 
ahead of you, not only to fulfill the Fed's primary mandate to 
conduct monetary policy to create maximum economic growth, full 
employment, and price stability, you do so in the face of an 
economy in deep recession, closing credit markets and 
unemployment rising at its fastest pace in a generation, having 
already cut interest rates to almost zero. You do so managing a 
balance sheet that has spiked to $2 trillion and now includes 
the remnants of an investment bank and the control of the 
world's largest insurance company. You do so having to conduct 
monetary policy in ways never tried before to unlock frozen 
credit markets, and you do so with an agency whose structure is 
virtually unchanged since its creation in 1913, when nearly a 
third of the Americans worked on farms, even as your mission 
has expanded exponentially from regulating the smallest banks 
in the country to the largest bank holding companies, from 
protecting consumers to being the lender of last resort for any 
company in the Nation.
    Mr. Chairman, I would say your plate is full, to put it 
mildly. As this Committee works to modernize our Nation's 
financial regulatory structure, the question is whether we 
should be giving you a bigger plate or whether we should be 
putting the Fed on a diet. I do not question your track record 
on monetary policy, as I have said--the Fed's primary goal. But 
when you keep asking an agency to take on more and more and 
more, it becomes less and less and less likely that the agency 
will succeed at any of it. And at the same moment, in my view, 
nothing will be more important for the Federal Reserve than 
getting monetary policy right. It is absolutely paramount, and 
I know you know that as well.
    So we welcome you to this Committee, and let me turn to 
Senator Shelby for any opening comments he may have.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Chairman Dodd.
    Chairman Bernanke, we welcome you back to the Committee. 
You have spent a lot of time with us.
    The economic and financial climate has deteriorated 
significantly since our last monetary policy hearing in July of 
2008. In response to the Congress, the administration and the 
Federal Reserve have taken dramatic steps to navigate our way 
through this crisis. Since last summer, the Federal Reserve's 
balance sheet has more than doubled in size and presently 
stands at about $2 trillion. This expansion is a result of 
extraordinary actions taken by you and the members of the Board 
of Governors. Some of these actions were institution specific 
while others involved establishing new programs aimed at 
providing liquidity to the banking system and unfreezing credit 
markets.
    Because it would take too much of our time this morning to 
describe each action and program in detail, I will be brief and 
only discuss a few of them. I would, however, strongly 
encourage Chairman Dodd to conduct hearings on all of these 
programs. The Federal Reserve has provided assistance to 
several large financial entities, according to their words, 
``in order to ensure financial market stability.''
    Acting along with Treasury and the FDIC, the Federal 
Reserve has intervened to rescue Citigroup and Bank of America 
by providing a backstop for large pools of their loans. The 
Federal Reserve has extended the safety net beyond the banking 
system by establishing two new lending facilities in connection 
with the bailout of AIG. These facilities are winding down 
AIG's holdings and mortgage-backed securities and credit 
default swap contracts. The Federal Reserve will continue to 
run a virtual alphabet soup of liquidity facilities through 
April 30, 2009, at the least.
    In more recent months, the Federal Reserve announced 
initiatives aimed specifically at stabilizing our housing and 
securitization markets. The Fed has announced that it will 
purchase up to $100 billion in debt obligations of Fannie Mae, 
Freddie Mac, and Federal home loan banks, as well as up to $500 
billion of mortgage-backed securities backed by Fannie Mae, 
Freddie Mac, and Ginnie Mae.
    Most recently, with securitization markets for all types of 
consumer credit virtually frozen, the Federal Reserve has 
announced the establishment of the Term Asset-backed Securities 
Loan Facility, or TALF. Under the TALF, the Federal Reserve 
Bank of New York will lend up to $200 billion on a non-recourse 
basis to holders of certain AAA-rated asset-backed securities 
backed by newly and recently originated consumer and small 
business loans. The New York Fed will lend an amount equal to 
the market value of the ABS less a haircut. The U.S. Treasury 
Department under the TARP will provide $20 billion of credit 
protection to the New York Fed in connection with the TALF.
    Given the scope of the Federal Reserve's recent actions, it 
seems unlikely that any future student will conclude that 
today's Federal Reserve was too timid in the face of this 
crisis, Mr. Chairman. Whether the Federal Reserve pursued the 
most effective actions will be another question, and that will 
also be the case for the efforts of the administration and the 
Congress, too.
    I hope that this Committee will use today's hearing to 
explore the effectiveness of the Federal Reserve's recent 
actions. One of the questions foremost in my mind, Mr. 
Chairman, is whether the Federal Reserve has thought about the 
long-term implications of its programs, its new programs.
    Chairman Bernanke, you have already begun discuss the need 
for an exit strategy, some of which will happen as credit 
conditions return to normal. Some of the new programs, however, 
have longer maturities. This presents a problem not only to you 
but for us. How do you decide when and how to remove the 
Federal Reserve from the market? This uncertainty may require 
the Fed to provide more clarity on when and how it will 
terminate these programs. In addition, Mr. Chairman, the 
Federal Reserve is likely to take more credit risk through the 
TALF than is customarily the case of its lending operations.
    This raises additional questions about transparency and 
what taxpayers should expect, and perhaps demand, from the 
Federal Reserve. Hopefully, Chairman Bernanke can begin to 
address these and other questions today.
    Thank you, Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Let me just inform my colleagues, by the way, that there 
will be a vote at 11:15 on the D.C. voting rights bill, and, 
Senator Menendez, we will try and work it so we just continue 
with the hearing and go in tranches. We use the word 
``tranche'' a lot these days, so we go in tranches to vote and 
continue the process of the Committee.
    Mr. Chairman, we thank you again for being before us this 
morning, and we welcome your statement.

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

    Mr. Bernanke. Thank you. Chairman Dodd, Senator Shelby, and 
Members of the Committee, I appreciate the opportunity to 
discuss monetary policy and the economic situation and to 
present the Federal Reserve's monetary policy report to the 
Congress.
    As you are aware, the U.S. economy is undergoing a severe 
contraction. Employment has fallen steeply since last autumn, 
and the unemployment rate has moved up to 7.6 percent. The 
deteriorating job market, considerable losses of equity and 
housing wealth, and tight lending conditions have weighed down 
on consumer sentiment and spending. In addition, businesses 
have cut back capital outlays in response to the softening 
outlook for sales, as well as the difficulty of obtaining 
credit.
    In contrast to the first half of last year, when robust 
foreign demand for U.S. goods and services provided some offset 
to weakness in domestic spending, exports slumped in the second 
half as our major trading partners fell into recession and some 
measures of global growth turned negative the first time in 
more than 25 years.
    In all, U.S. real gross domestic product declined slightly 
in the third quarter of 2008, and that decline steepened 
considerably in the fourth quarter. The sharp contraction in 
economic activity appears to have continued into the first 
quarter of 2009.
    The substantial declines in the prices of energy and other 
commodities last year and the growing margin of economic slack 
have contributed to a substantial lessening of inflation 
pressures. Indeed, overall consumer price inflation measured on 
a 12-month basis was close to zero last month. Core inflation, 
which excludes the direct effects of food and energy prices, 
also has declined significantly.
    The principal cause of the economic slowdown was the 
collapse of the global credit boom and the ensuing financial 
crisis, which has affected asset values, credit conditions, and 
consumer and business confidence around the world. The 
immediate trigger of the crisis was the end of the housing 
booms in the United States and other countries and the 
associated problems in mortgage markets, notably the collapse 
of the U.S. subprime mortgage market.
    Conditions in housing and mortgage markets have proved a 
serious drag on the broader economy, both directly through 
their impact on residential construction and related industries 
and on household wealth, and indirectly through the effects of 
rising mortgage delinquencies on the health of financial 
institutions. Recent data show that residential construction 
and sales continue to be very weak, house prices continue to 
fall, and foreclosure starts remain at very high levels.
    The financial crisis intensified significantly in September 
and October. In September, the Treasury and the Federal Housing 
Finance Agency placed the Government-sponsored enterprises 
Fannie Mae and Freddie Mac into conservatorship, and Lehman 
Brothers Holdings filed for bankruptcy. In the following weeks, 
several other large financial institutions failed, came to the 
brink of failure, or were acquired by competitors under 
distressed circumstances.
    Losses at a prominent money market mutual fund prompted 
investors, who had traditionally considered money market mutual 
funds to be virtually risk free, to withdraw large amounts from 
such funds. The resulting outflows threatened the stability of 
short-term funding markets, particularly the commercial paper 
market, upon which corporations rely heavily for their short-
term borrowing needs.
    Concerns about potential losses also undermined confidence 
in wholesale bank funding markets, leading to further increases 
in bank borrowing costs and a tightening of credit availability 
from banks.
    Recognizing the critical importance of the provision of 
credit to businesses and households from financial 
institutions, the Congress passed the Emergency Economic 
Stabilization Act last fall. Under the authority granted by 
this act, the Treasury purchased preferred shares in a broad 
range of depository institutions to shore up their capital 
basis. During this period, the FDIC introduced its Temporary 
Liquidity Guarantee Program, which expanded its guarantees of 
bank liabilities to include selected senior unsecured 
obligations and all non-interest-bearing transactions deposits. 
The Treasury, in concert with the Federal Reserve and the FDIC, 
provided packages of loans and guarantees to ensure the 
continued stability of Citigroup and Bank of America, two of 
the world's largest banks.
    Over this period, governments in many foreign countries 
also announced plans to stabilize their financial institutions, 
including through large-scale capital injections, expansions of 
deposit insurance, and guarantees of some forms of bank debt.
    Faced with the significant deterioration of financial 
market conditions and the substantial worsening of the economic 
outlook, the Federal Open Market Committee continued to ease 
monetary policy aggressively in the final months of 2008, 
including a rate cut coordinated with five other major central 
banks. In December, the FOMC brought its target for the Federal 
funds rate to a historically low range of zero to one-quarter 
percent, where it remains today. The FOMC anticipates that 
economic conditions are likely to warrant exceptionally low 
levels of the Federal funds rate for some time.
    With the Federal funds rate near its floor, the Federal 
Reserve has taken additional steps to ease credit conditions. 
To support housing markets and economic activity more broadly 
and to improve mortgage market functioning, the Federal Reserve 
has begun to purchase large amounts of agency debt and agency 
mortgage-backed securities. Since the announcement of this 
program last November, the conforming fixed mortgage rate has 
fallen nearly 1 percentage point. The Federal Reserve also 
established new lending facilities and expanded existing 
facilities to enhance the flow of credit to businesses and 
households.
    In response to the heightened stress in bank funding 
markets, we increased the size of the Term Auction Facility to 
help ensure that banks could obtain the funds they need to 
provide credit to their customers, and we expanded our network 
of swap lines with foreign central banks to ease conditions in 
interconnected dollar funding markets at home and abroad. We 
also established new lending facilities to support the 
functioning of the commercial paper market and to ease 
pressures on money market mutual funds.
    In an effort to restart securitization markets to support 
the extension of credit to consumers and small businesses, we 
joined with the Treasury to announce the Term Asset-backed 
Securities Loan Facility, or TALF. The TALF is expected to 
begin extending loans soon.
    The measures taken by the Federal Reserve, other U.S. 
Government entities, and foreign governments since September 
have helped to restore a degree of stability to some financial 
markets. In particular, strains in short-term funding markets 
have eased notably since last fall, and London Interbank 
Offered Rates, or LIBOR, upon which borrowing costs for many 
households and businesses are based, have decreased sharply.
    Conditions in the commercial paper market also have 
improved, even for lower-rated borrowers, and the sharp 
outflows from money market mutual funds seen in September have 
been replaced by modest inflows. Corporate risk spreads have 
declined somewhat from extraordinarily high levels, although 
these spreads remain elevated by historical standards.
    Likely spurred by the improvements in pricing and 
liquidity, issuance of investment-grade corporate bonds has 
been strong, and speculative-grade issuance, which was near 
zero in the fourth quarter, has picked up somewhat. As I 
mentioned earlier, conforming fixed mortgage rates for 
households have declined. Nevertheless, despite these favorable 
developments, significant stresses persist in many markets. 
Notably, most securitization markets remain shut other than 
that for conforming mortgages, and some financial institutions 
remain under pressure.
    In light of ongoing concerns over the health of financial 
institutions, the Secretary of the Treasury recently announced 
a plan for further actions. This plan includes four principal 
elements.
    First, a new Capital Assistance Program will be established 
to ensure that banks have adequate buffers of high-quality 
capital based on results of comprehensive stress tests to be 
conducted by the financial regulators, including the Federal 
Reserve.
    Second is a Private-Public Investment Fund in which private 
capital will be leveraged with public funds to purchase legacy 
assets from financial institutions.
    Third, the Federal Reserve, using capital provided by the 
Treasury, plans to expand the size and scope of the TALF to 
include securities backed by commercial real estate loans and 
potentially other types of asset-based securities as well.
    And, fourth, the plan includes a range of measures to help 
prevent unnecessary foreclosures.
    Together, over time, these initiatives should further 
stabilize our financial institutions and markets, improving 
confidence and helping to restore the flow of credit needed to 
promote economic recovery.
    The Federal Reserve is committed to keeping the Congress 
and the public informed about its lending programs and balance 
sheet. For example, we continue to add to the information shown 
in the Fed's H41 statistical release, which provides weekly 
detail on the balance sheet and the amounts outstanding for 
each of the Federal Reserve's lending facilities. Extensive 
additional information about each of the Federal Reserve's 
lending programs is available online.
    The Fed also provides bimonthly reports to the Congress on 
each of its programs that rely on the Section 13(3) 
authorities. Generally, our disclosure policies reflect the 
current best practices of major central banks around the world.
    In addition, the Federal Reserve's internal controls and 
management practices are closely monitored by an independent 
Inspector General, outside private sector auditors, and 
internal management and operations divisions, and through 
periodic reviews by the Government Accountability Office.
    All that said, we recognize that recent developments have 
led to a substantial increase in the public's interest in the 
Fed's programs and balance sheet. For this reason, we at the 
Fed have begun a thorough review of our disclosure policies and 
the effectiveness of our communication. Today, I would like to 
highlight two initiatives.
    First, to improve public access to information concerning 
Fed policies and programs, we recently unveiled a new section 
of our Web site that brings together in a systematic and 
comprehensive way the full range of information that the 
Federal Reserve already makes available, supplemented by 
explanations, discussions, and analyses. We will use that Web 
site as one means of keeping the public and the Congress fully 
informed about Fed programs.
    Second, at my request, Board Vice Chairman Donald Kohn is 
leading a committee that will review our current publications 
and disclosure policies relating to the Fed's balance sheet and 
lending policies. The presumption of the committee will be that 
the public has the right to know and that the non-disclosure of 
information must be affirmatively justified by clearly 
articulated criteria for confidentiality based on factors such 
as reasonable claims to privacy, the confidentiality of 
supervisory information, and the need to ensure the 
effectiveness of policy.
    In their economic projections for the January FOMC meeting, 
monetary policymakers substantially marked down their forecasts 
for real GDP this year relative to the forecast they had 
prepared in October. The central tendency of their most recent 
projections for real GDP implies a decline of one-and-one-half 
percent to one-and-one-quarter percent over the four quarters 
of 2009. These projections reflect an expected significant 
contraction in the first half of this year, combined with an 
anticipated gradual resumption of growth in the second half.
    The central tendency for the unemployment rate in the 
fourth quarter of 2009 was marked up to a range of eight-and-a-
half percent to eight-and-three-quarters percent. Federal 
Reserve policymakers continue to expect moderate expansion next 
year, with a central tendency of two-and-a-half percent to 
three-and-a-quarter percent growth in real GDP and a decline in 
the unemployment rate by the end of 2010 to a central tendency 
of 8 percent to eight-and-a-quarter percent.
    FOMC participants marked down their projections for overall 
inflation in 2009 to a central tendency of one-quarter percent 
to 1 percent, reflecting expected weakness in commodity prices 
and the disinflationary effects of significant economic slack. 
The projections for core inflation also were marked down to a 
central tendency bracketing 1 percent. Both overall and core 
inflation are expected to remain low over the next 2 years.
    This outlook for economic activity is subject to 
considerable uncertainty, and I believe that, overall, the 
downside risks probably outweigh those on the upside. One risk 
arises from the global nature of the slowdown, which could 
adversely affect U.S. exports and financial conditions to an 
even greater degree than currently expected.
    Another risk arises from the destructive power of the so-
called adverse feedback loop in which weakening economic and 
financial conditions become mutually reinforcing. To break the 
adverse feedback loop, it is essential that we continue to 
complement fiscal stimulus with strong government action to 
stabilize financial institutions and financial markets.
    If actions taken by the administration, the Congress, and 
the Federal Reserve are successful in restoring some measure of 
financial stability, and only if that is the case, in my view, 
there is a reasonable prospect that the current recession will 
end in 2009 and that 2010 will be a year of recovery. If 
financial conditions improve, the economy will be increasingly 
supported by fiscal and monetary stimulus, the salutary effects 
of the steep decline in energy prices since last summer, and 
the better alignment of business inventories and final sales, 
as well as the increased availability of credit.
    To further increase the information conveyed by the 
quarterly projections, FOMC participants agreed in January to 
begin publishing their estimates of the values to which they 
expect key economic variables to converge over the longer run, 
say at a horizon of 5 to 6 years, under the assumption of 
appropriate monetary policy and in the absence of new shocks to 
the economy. The central tendency for the participants' 
estimates of a longer run growth rate of real GDP is two-and-a-
half percent to two-and-three-quarters percent. As to the 
longer rate of unemployment, it is four-and-three-quarter 
percent to 5 percent. And as to the longer rate of inflation, 
it is one-and-three-quarter percent to 2 percent, with the 
majority of participants looking for 2 percent inflation in the 
long run.
    These values are all notably different from the central 
tendencies of the projections for 2010 and 2011, reflecting the 
view of policymakers that a full recovery of the economy from 
the current recession is likely to take more than 2 or 3 years.
    The longer-run projections for output growth and 
unemployment may be interpreted as the Committee's estimates of 
the rate of growth of output and the unemployment rate that are 
sustainable in the long run in the United States, taking into 
account important influences such as the trend in growth rates 
of productivity in the labor force, improvements in worker 
education and skills, the efficiency of the labor market at 
matching workers and jobs, government policies affecting 
technological development, or the labor market and other 
factors.
    The longer-run projections of inflation may be interpreted, 
in turn, as the rate of inflation that FOMC participants see as 
most consistent with the dual mandate given to it by the 
Congress, that is the rate of inflation that promotes maximum 
sustainable employment while also delivering reasonable price 
stability.
    This further extension of the quarterly projection should 
provide the public a clearer picture of the FOMC's policy 
strategy for promoting maximum employment and price stability 
over time. Also, increased clarity about the FOMC's views 
regarding longer-run inflation should help to better stabilize 
the public's inflation expectations, thus contributing to 
keeping actual inflation from rising too high or falling too 
low.
    At the time of our last monetary policy report, the Federal 
Reserve was confronted with both high inflation and rising 
unemployment. Since that report, however, inflation pressures 
have receded dramatically while the rise in the unemployment 
rate has accelerated and financial conditions have 
deteriorated. In light of these developments, the Federal 
Reserve is committed to using all available tools to stimulate 
economic activity and to improve financial market functioning.
    Toward that end, we have reduced the target for the Federal 
Funds Rate close to zero and we have established a number of 
programs to increase the flow of credit to key sectors of the 
economy. We believe that these actions, combined with the broad 
range of other fiscal and financial measures being put into 
place, will contribute to a gradual resumption of economic 
growth and improvement in labor market conditions in a context 
of low inflation. We will continue to work closely with the 
Congress and the administration to explore means of fulfilling 
our mission of promoting maximum employment and price 
stability.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Mr. Chairman.
    I am going to try to follow this 5-minute rule pretty 
carefully today with a lot of Members here so we get around the 
table as quickly as we can.
    I am not a Pollyanna, nor are you, and so I don't want to 
overstate the case, but I found the paragraph, the second 
paragraph on page four, in reading your statement last evening, 
and the words on page seven, where you talk about the 
possibility of coming out of this recession in 2010, to be 
encouraging. I wanted, in the context of your responses today--
because obviously, the risk is on the downside. Your statement 
is pretty stark and certainly a bleak picture, but there is 
some hope that I think it is important for us to transmit to 
the American people, as well, that we can and we will get out 
of this along the way. I think confidence and building that 
confidence, not false confidence but confidence based on tough 
decisions that we can make and should make, I think are 
important to communicate, as well.
    Let me, if I can, raise two quick questions with you. I had 
a town hall meeting on Sunday in Manchester, Connecticut, at 
Manchester Community College, on higher education, how to 
navigate student loans. A couple raised a question after we had 
a presentation of what steps could be taken and the kind of 
information available for people and they got up and they said, 
look, we have put aside. We bought stock. We did things to 
prepare for our children's education and all of a sudden it is 
gone. Here we are with children age 15, 16, or 17 getting ready 
now to go on and the very nest egg we were building for them is 
no longer there.
    In a sense, what I would like to ask you, given the fact 
that we have seen an 18 percent decline in the housing values, 
a 40 percent decline in the stock market over the last several 
years, can people who are in an age group--put aside education 
for a minute, the student loans--can people on the brink of 
retirement, in your view, can they retire? Are people going to 
be prohibited from retiring because of what they have lost in 
the value of their homes and in the stock market, 401(k), for 
instance?
    Mr. Bernanke. Well, Mr. Chairman, it is going to depend on 
individual circumstances. I am afraid it is the case that some 
people will find that their assets are not, at this point, 
adequate to allow them to retire as they had planned. Many 
people have suffered from losses in asset values. It is in part 
related to a correction relative to perhaps inflated asset 
values, particularly in the housing market, prior to this time. 
But we are also seeing very heavy risk aversion and liquidity 
premiums, that is, people are just very, very averse to risk at 
this point and that is also driving down asset prices.
    So I understand that this is a very difficult situation for 
savers as it is for workers and homeowners, and all I can say 
is the Federal Reserve is committed to doing everything we can 
to restore economic stability. I do believe that once the 
economy begins to recover, we will see improvements in 
financial markets. In fact, I think those two things go very 
closely together.
    Chairman Dodd. So your statement or your response would be 
that, one, it would depend on individual cases, but that you 
believe that people will be able to retire with some security.
    Mr. Bernanke. Well, I certainly hope so. Certainly, Social 
Security and other programs, defined benefit plans, still 
remain. But I know from my own case and my friends and 
relatives that losses in defined contribution retirement funds 
have been significant, particularly in stock portfolios, and 
that is certainly going to affect people's plans in the short 
term. I am hopeful that we will see some improvement as the 
economy improves over the next year or two.
    Chairman Dodd. Did I sense a sigh of relief that we didn't 
privatize Social Security?
    Mr. Bernanke. Well, we never got that far on that proposal, 
Mr. Chairman.
    Chairman Dodd. Gratefully, would you agree?
    Mr. Bernanke. Well, it depends on the details. There were 
so many different plans being proposed.
    Chairman Dodd. Can you imagine if your Social Security were 
tied into the stock market today, what it would be like?
    Mr. Bernanke. Well, if they were all tied to the stock 
market, that would certainly be a problem, right.
    Chairman Dodd. Yes. Let me, if I can in the minute or so 
left here, I noted in my opening comments that housing and 
autos have historically led us out of recessions in many ways. 
I don't know if you agree or not, but it is ironic that 
housing, and to a lesser degree autos, have led us into this 
recession. Who is going to lead us out of this recession? What 
sector of the economy?
    Mr. Bernanke. Well, we have seen a very broad-based 
weakness. Housing is very central. At this point, the housing 
market has reversed the boom that we saw earlier in the decade. 
In fact, we are now at levels of construction and price 
declines that we have not seen for a very long time, if ever, 
and so I would anticipate some stabilization in the housing 
market going forward and eventually demographic trends, 
household formation, economic growth will begin to create 
recovery in the housing market.
    Likewise, people are very reluctant right now to make 
commitments to consumer durables like automobiles. I think the 
current rates of auto sales are below what we will see once the 
economy begins to normalize. So I think those sectors will be 
part of the recovery. But in general, as we see confidence 
coming back, particularly consumer spending on discretionary 
items, those areas will begin to strengthen and we will see a 
broad-based recovery.
    Chairman Dodd. I should have mentioned in prefacing my 
question, I am, at least for my part, anyway, grateful to the 
administration for stepping up on the housing issue, the $75 
billion that has been committed in the mitigation on 
foreclosures. I wish we had done that a year ago. It might have 
made the situation less dramatic than it is today, but I 
welcome that move, as well.
    With that, let me turn to Senator Shelby, and look at that, 
right on the money here, so 5 minutes.
    Senator Shelby. I will try to do the same, Mr. Chairman. 
Thank you.
    Adequacy of bank capital, I would like to get into that. 
Mr. Chairman, regulators from each part of the banking 
industry, including the Federal Reserve, have testified 
multiple times before the Banking Committee in the past few 
years that the banking industry was healthy and strong, yet we 
are now discussing taking very drastic measures to recapitalize 
the very same system. A lot of people wonder, where were the 
regulators in the past 5 or 6 years, including the Federal 
Reserve.
    For example, in 2004, before the Banking Committee, FDIC 
Chairman Powell said, and I quote, ``I am pleased to report''--
that is to the Banking Committee--``that the FDIC insured 
institutions are as healthy and sound as they have ever been.''
    Additionally, in 2004, OTS Director James Gilleran stated 
before the Banking Committee, and I quote, ``It is my pleasure 
to report on a thrift industry that is strong and growing in 
asset size. While we continue to maintain a watchful eye on 
interest rate risk in the thrift industry, profitability, asset 
quality, and other key measures of financial health are at or 
near record levels.''
    Also before this committee in 2004, Comptroller of the 
Currency John Hawke testified, ``National banks continue to 
display strong earnings, improving credit quality following the 
recent recession and sound capital positions.'' He even said 
that banks have adopted better risk management techniques.
    In 2005, your predecessor of the Fed, Chairman Alan 
Greenspan, said before the Banking Committee here, ``Nationwide 
banking and widespread securitization of mortgages make 
financial intermediation less likely to be impaired than it was 
in some previous episodes of lethal house price correction.''
    In fact, as recently as 2008, Chairman of the FDIC Bair 
testified and said, and I quote, ``The vast majority of 
institutions remain well capitalized, which will help them 
withstand the difficult challenges in 2008 while broader 
economic conditions improve.''
    Comptroller Dugan, Comptroller of the Currency, said here 
before the Banking Committee in 2008, and I will quote, 
``Despite these strains, the banking system remains 
fundamentally sound, in part because it entered this period of 
stress in a much stronger condition.''
    Finally, in 2008, Federal Reserve Vice Chairman Kohn 
testified before this Committee, and I quote, ``The U.S. 
banking system is facing some challenges, but it remains in 
sound overall condition, having entered the period of recent 
financial turmoil with solid capital and strong earnings. The 
problems in the mortgage and housing markets have been highly 
unusual and clearly some banking organizations have failed to 
manage their exposures well and have suffered losses as a 
result. But in general, these losses should not threaten their 
viability.''
    Chairman Bernanke, are your capital measures and amounts of 
capital adequate? You are regulator of the largest banks. What 
does the present state of the banking industry tell us about 
our capital regime, and what does it mean if banks are 
adequately capitalized, yet somehow we need to spend billions, 
if not trillions, of dollars to stabilize the system?
    Mr. Bernanke. Well, that is a very long question, Senator 
Shelby.
    Chairman Dodd. You have a minute and 30 seconds to answer 
the question.
    Mr. Bernanke. The banks did have extensive capital coming 
into this crisis, but, of course, the crisis itself was 
extraordinary in its size. We could talk at some length about 
the failures of regulators, including the Federal Reserve, to 
prevent the credit crisis and prevent the losses that have been 
affected.
    Going forward, we need to think about the Basel II regime, 
on which capital rules are now set. The general principles of 
the Basel II regime are that capital should be related to the 
risks of the assets which are being held.
    But I think we have learned several things. First, that we 
need to be more aggressive in figuring out what the risks are 
and make sure that we are stress testing, making sure that we 
are being conservative in terms of assigning capital to 
individual kinds of assets. There certainly were some assets 
that were underweighted in terms of their risk characteristics 
when the capital was assigned. We need to look at a variety of 
other things, like off-balance sheet exposures and other things 
that were not adequately represented in the Basel II framework.
    And there are other elements which the Basel Committee is 
looking at. Just to mention two, there probably were 
improvements in risk management and risk measurement over the 
period discussed, but they weren't adequate, obviously, and we 
need to do a lot more work for making sure that bank companies 
have enterprise-wide comprehensive risk management techniques. 
In addition, and this is something that the Basel Committee has 
been focused on, we need to make sure they have adequate 
liquidity, as well as capital.
    So there is a lot to be done. You are absolutely right in 
pointing out the deficiencies and there is a lot of work that 
we regulators, the international community, has to do to 
strengthen that capital standard.
    Senator Shelby. Thank you. My time is up.
    Chairman Dodd. Thank you, Senator.
    Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman, and thank 
you, Chairman Bernanke.
    Let me associate myself with Chairman Dodd's remarks about 
in a crisis, you have been providing very helpful and 
thoughtful leadership. I also would associate myself with 
consumer protections and other supervisory activities which we 
will correct going forward, but thank you for your leadership 
in this crisis.
    You point out repeatedly in your comments and the Open 
Market Committee statement that unemployment is a significant 
problem in the country. In fact, the Open Market Committee 
indicates that it could reach 9.2 percent in 2009 and 2010, 
even with an improving financial market and the credit markets. 
Is that the conclusion, for the record?
    Mr. Bernanke. The actual forecast was a little under--was 
under 9 percent.
    Senator Reed. Under 9 percent?
    Mr. Bernanke. But certainly within the range of error is 9 
percent would be included.
    Senator Reed. One of the things that has been done in the 
stimulus package is extended unemployment benefits. Many 
economists indicate that that is a very wise investment, since 
for every dollar of benefits, you get roughly $1.60 in GDP 
growth. Is that your presumption or your conclusion also?
    Mr. Bernanke. I don't have a precise number. From a 
spending perspective, though, it is certainly true that 
unemployment benefits are much more likely to be spent than the 
average dollar because people don't have the income. They need 
those benefits.
    Senator Reed. Also, in the Open Market Committee report, 
they indicate that the labor market is very weak but the 
declines might be tempered a bit because of the availability of 
extended unemployment benefits, that, in fact, people are still 
in the market looking for jobs because they have the benefits 
to sustain them in that search. Again, I assume you share that 
conclusion?
    Mr. Bernanke. Well, unemployment benefits can have the 
effect of slightly raising the unemployment rate because people 
have a little bit more time to look. That is a negative in one 
sense--that the unemployment rate is a bit higher. On the other 
hand, it gives people more time and more resources so they can 
find a better job and not take the first thing necessarily that 
they see.
    But unemployment benefits are obviously a very useful 
policy tool and have been used in every recession. In a 
situation like the present, where unemployment is very high, it 
is certainly understandable that Congress would want to provide 
some relief for the unemployed.
    Senator Reed. There has been some discussion that certain 
States would decline to participate fully. If that was not a 
few individual States but a significant number, that would 
effectively contradict the stimulus effect of the unemployment 
benefits, let alone not help people who need help, is that a--
--
    Mr. Bernanke. Which effect? I am sorry.
    Senator Reed. It would contradict the stimulus effects, 
that if a widespread declining of extended unemployment 
benefits by States refusing to participate in programs, if that 
was done on a----
    Mr. Bernanke. If unemployment benefits are not distributed 
to the unemployed, then obviously they won't spend them and it 
won't have that particular element of stimulus.
    Senator Reed. So if this was done on a wide basis, it would 
be counterproductive, not productive?
    Mr. Bernanke. It would reduce the stimulus effect of the 
package, yes.
    Senator Reed. Let me follow up briefly, because my time is 
short, on Senator Shelby's comments about capital standards. 
Yesterday, the regulators said, currently, the major U.S. 
banking institutions have capital in excess of the amount 
required to be considered well capitalized, which begs the 
question, what is the measure, Tier I capital, or tangible 
common equity, or any other measure? Can you help us 
understand?
    Mr. Bernanke. Well, the major banks all meet current 
regulatory capital standards, and well capitalized is a well 
defined regulatory term. The purpose of these assessments we 
are going to do going forward is to make sure that banks have 
enough capital not only to be well capitalized in what we 
expect to be the weak conditions that we will see in the next 
year, but even under conditions that are weaker than expected. 
And moreover, we want to make sure that they have good quality 
capital, that is that a sufficient portion of their capital is 
in common stock and not in other forms of capital.
    So the purpose of these tests is to try to assess how much 
additional capital and what kind of capital they need so they 
will be able to lend and support the economy even in a 
situation worse than we currently expect.
    Senator Reed. Listening to your response to Senator Shelby, 
though, you seem to be skeptical about the adequacy of the 
current test, the current capital test, capital definitions. So 
even if we move through this very difficult moment, someone 
passes the stress test or gets help if they can't pass the 
stress test, there is real question in your mind about how 
regulators measures capital, what should be included, is that a 
fair assessment?
    Mr. Bernanke. We need to do work on that, certainly. For 
the moment now, we are trying to be conservative and trying to 
make sure that the banks will be able to fulfill their 
functions going forward.
    Senator Reed. Thank you very much. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator, very much.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    Welcome, Chairman Bernanke. Outstanding Fed lending hit 
about $2.3 trillion in December. It has fallen to about $1.9 
trillion, but you have pledged another $1 trillion in new 
lending. The total volume of loans made over the last months 
may be many times higher than that, but those of us outside the 
Fed do not have access to that information.
    Your testimony before this Committee on TARP was that we 
needed transparency so the American people could understand. 
One of the causes of the recession is the American people don't 
believe you or anybody sitting here is telling them the truth. 
That is one of the problems. But you have not been open about 
the Fed's balance sheet. I think the American people have a 
right to know where that money is going. When are you going to 
tell the public who is borrowing from the Fed and what they 
have pledged as collateral? When are we going to get the 
transparency from the Fed?
    Mr. Bernanke. Well, Senator, as I mentioned in my 
testimony, we are going to go beyond what is best practice 
among the world's central banks and go a step further and make 
sure we provide all the information we can. We have just 
unveiled the new Web site, which has extensive information, 
including information about collateral, including descriptions 
and discussions of each of the programs, and----
    Senator Bunning. To whom the money is going?
    Mr. Bernanke. We are looking at all aspects. By the way, it 
is not all lending. Half-a-trillion is just Treasury securities 
we hold, so you could count that as lending to the Treasury, I 
guess. But about half the money we hold is short-term 
collateralized recourse loans to financial institutions which 
assures them of sufficient liquidity so that they will be 
stable and able to make loans and know that there is liquidity 
there when it is available.
    Now, hundreds of years of central banking experience shows 
that if you publish the names of the banks that receive those 
loans, there is a risk that the market will say that there is 
something wrong with them, that there is a stigma of some kind, 
and they will refuse to come to the window in the first place 
and that causes the whole purpose of the program to break down.
    So we can provide a great deal of information about the 
number of institutions. There are hundreds of them. They are 
well collateralized, short-term loans. They provide an 
important public purpose. But to provide the names of each 
borrower, and it would include most of the, or many of the 
banks in the United States, would defeat the important purpose 
of the policy.
    Senator Bunning. OK. I have been trying to get to the 
bottom of who signed off on the original TARP loans to 
Citigroup and the Bank of America for several months. Those 
loans were only supposed to go to healthy--that is in the 
legislation--healthy banks. Did you approve those initial 
loans, or who did if you didn't?
    Mr. Bernanke. Well, Senator, that would be the Treasury's 
approval, but as I recall, the programs had several components. 
There was a broad-based CPP, Capital Purchase Program, that was 
aimed at so-called healthy or viable banks, and that was widely 
available to any bank that wanted to apply for it. But there 
was also a special targeted program that was for banks that 
were in significant trouble and needed support to remain viable 
and healthy, and that particular program included, among other 
things, tougher conditions and tougher restrictions on 
executive compensation, for example. So that was a different 
component of the TARP.
    Senator Bunning. Well, we know all those things, but we 
don't know who approved the amount of money that went----
    Mr. Bernanke. The Treasury. The Treasury.
    Senator Bunning. The Treasury. You are telling me the 
Treasury?
    Mr. Bernanke. Yes.
    Senator Bunning. Do you believe the chaos that followed 
Lehman Brothers' bankruptcy was a result of the bankruptcy 
itself or the market realization that not everyone would be 
bailed out?
    Mr. Bernanke. Well, Senator, as I discussed in my 
testimony, the whole period from mid-September to early October 
was an intense financial crisis that was, in turn, triggered to 
some extent by a weakening economic condition both in the 
United States and around the world. To some extent, Lehman was 
a result of the broad financial crisis that was hitting a 
number of firms. You know, quite a number of large firms came 
under pressure during that period. And so in some sense, Lehman 
was a symptom as well as a cause. But I do think that the 
failure of Lehman was a major----
    Senator Bunning. But there was picking and choosing between 
winner and loser here. You picked Bear Stearns to save and you 
let Lehman Brothers go down the tubes.
    Mr. Bernanke. Two points, Senator. First, we did not choose 
to let Lehman fail. We had no option because we had no 
authority to stop it.
    But second, I do believe that the failure of Lehman 
Brothers and its impact on the world financial market confirms 
that we made the right judgment with Bear Stearns, that the 
failure of a large international financial institution has 
enormously destructive effects on the financial system and 
consequently on----
    Senator Bunning. In other words, there are too many--there 
are some banks that are too big to fail?
    Mr. Bernanke. Absolutely.
    Senator Bunning. Thank you.
    Chairman Dodd. Thank you, Senator.
    Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman. Thank you, Mr. 
Chairman.
    First question, it is clear one of the key problems over 
the past few years has been excessive risk taken by financial 
institutions. Some of that was by big depository institutions. 
Some was by smaller hedge funds, private equity funds.
    Do you agree with me we need to more greatly supervise 
smaller players, such as hedge funds and private equity funds, 
particularly in terms of transparency and systemic risk which 
we find smaller and smaller places can cause? And do you agree 
more broadly we need to put in place stronger curbs on risk 
taking in particular on the amount of leverage that financial 
institutions, whether large or small, use in their investing 
strategies?
    Mr. Bernanke. Well, Senator, I think we need a more 
macroprudential oversight approach, which means that we need to 
be looking at the whole market, the whole financial system, not 
just each individual institution thought of as an individual 
entity. And that would require, I think, at least gathering 
information about a range of financial institutions and markets 
to understand what is developing in those markets.
    Senator Schumer. Isn't it true that smaller institutions 
can cause systemic risk because there are counterparties, it is 
almost like a ping-pong ball bouncing from one place to 
another?
    Mr. Bernanke. Well, they can, but it is more likely if 
either there is a large number of them in the same boat----
    Senator Schumer. In the same----
    Mr. Bernanke. For example, mortgage companies a couple 
years ago. Or, on the other hand, I think for a given 
institution, a much larger, more complex institution is more 
likely to----
    Senator Schumer. But you do not rule out some regulation of 
the smaller----
    Mr. Bernanke. Well, we already have regulation. I think we 
should have an oversight of the whole system. But, Senator, I 
guess I would say that given the ``too big to fail'' problem, 
and agreeing with Senator Bunning that that exists, I was not 
saying that I in any way approved of it. I think it is a major 
issue, a major problem. One approach to dealing with ``too big 
to fail'' is to strengthen the oversight of those firms which 
may be considered too big to fail.
    Senator Schumer. Well, that does not answer my question. I 
asked you about the small ones, and you are giving me an answer 
about the big ones.
    Mr. Bernanke. Well, you know, I think if you are going to 
prioritize resources, you have to look where the biggest risks 
are. And I think big risks are in the big firms. But you also 
have to look at the system as a whole, and that would involve 
looking perhaps not so much at the individual bank on the 
corner, but maybe at an industry group. It is like mortgage 
brokers, for example.
    Senator Schumer. Yes. You know, one of them might not have 
caused the problem, but a whole bunch did.
    Mr. Bernanke. That is what I was trying to convey, yes.
    Senator Schumer. The same thing with smaller institutions 
as well, and you do have to look at them--for instance, 
registration?
    Mr. Bernanke. No, I think that clearly one of the lessons 
is that uneven oversight and regulation of mortgage extension 
was a big issue.
    Senator Schumer. And would you address the leverage 
question I asked?
    Mr. Bernanke. Well, leverage is the inverse of the capital 
ratio, and that boils down to making sure that our capital 
standards are strong and appropriately adjust for risk and the 
like. And as I said to Senator Shelby, we need to make sure 
going forward that our capital standard is----
    Senator Schumer. There are a lot of institutions with no 
capital standards, but they were not banks and regulated by 
you, who used huge leverage, 30:1, 40:1, 50:1. So even the 
lowly mortgage became very risky at that level.
    Mr. Bernanke. Whose leverage are you referring to?
    Senator Schumer. You know, when somebody would put $1 of 
capital and borrow $30 and invest $31, and yet they lose that 
$1 and they are kaput.
    Mr. Bernanke. I think you do need to make sure there is 
adequate capital in financial institutions, and when they 
extend loans--for example, mortgages--they need to do a good 
job of underwriting. And that would involve adequate 
downpayments and verification of income, for example.
    Senator Schumer. But, again, I am saying there are 
institutions that use this leverage that you did not have any 
capital standards for because you were not statutorily required 
to do it.
    Mr. Bernanke. If I may----
    Senator Schumer. How do we deal with the leverage issue for 
non-depository institutions is what I am asking.
    Mr. Bernanke. Well, I think more broadly----
    Senator Schumer. If at all.
    Mr. Bernanke. More broadly, the Congress needs to think 
about how to create a more uniform regulatory oversight over 
the entire system and avoid existing gaps or uneven coverage. 
And that is a problem not just for leverage, but for all other 
aspects.
    Senator Schumer. Right. Another question, a broader 
question. You, of course, studied the Great Depression. Many 
people say that we are in a different type of an economy 
because it is more interconnected; knowledge is more 
interconnected; financial relationships are more 
interconnected. It means in a certain sense things go down 
quicker because it does not take time to spread from one place 
to the other, whether it be countries, industries, or whatever. 
But then when things change, the psychology changes, you hit 
bottom, it goes up quicker.
    Do you buy that? I am asking you, were you more a student 
of the V theory or the L theory in terms of where we are? We 
know we are going down now, and we have not hit bottom yet. But 
will we bounce up quickly, in all likelihood, or just stay 
flat?
    Mr. Bernanke. Senator, if there is one message I would like 
to leave you, it is that if we are going to have a strong 
recovery, it has to be on the back of a stabilization of the 
financial system, and it is basically black and white. If we 
stabilize the financial system adequately, we will get a 
reasonable recovery. It might take some time. If we do not 
stabilize the financial system, we are going to founder for 
some time.
    Senator Schumer. Just one final comment. Saying that we 
will be back moving forward in 2010 is pretty much a V theory, 
not an L theory, if we stabilize the system.
    Mr. Bernanke. Well, the projections we gave are for the 
labor market still to be weak through 2010. We have seen in the 
last few recessions that the labor market has been slow to 
recover after the real economy, in terms of total output, has 
begun to recover.
    Senator Schumer. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Senator Corker.
    Senator Corker. Thank you, Mr. Chairman, and, Chairman 
Bernanke, thank you for your service, and certainly that last 
comment, which I think many people have been saying. The cure 
is stabilizing the financial system, and I know we have done a 
lot of different things over the last 5 or 6 weeks. But that, 
in essence, is the cure.
    I wonder if there is a vision or some kind of integrated 
discussion that is taking place between what you are doing and 
Treasury. I get the sense that we continue to sort of create 
programs, which I appreciate some of, but is there a vision or 
some kind of integrated sense of purpose that is being 
discussed and an outcome, I guess, that the two of you and 
others are arriving at?
    Mr. Bernanke. Yes, sir. The Treasury plan that Secretary 
Geithner proposed recently is a Treasury product. They are the 
lead on that. But it was developed in close consultation with 
the Federal Reserve and with the other regulatory agencies, 
like the OCC and the FDIC. And we are all going to work 
together on it, and we see it as having the major components.
    If you look at historical examples of recoveries of 
financial systems, you have supervisory review to make sure 
that you understand what is on the balance sheets. You have 
capital being injected. You have taking bad assets off the 
balance sheet, the asset purchases. In our case, we are doing 
also the asset-backed securities program, foreclosure 
mitigation--all those things. So it is a multiple-component 
plan, and we are all working together on it to try to make it 
as effective as possible.
    Senator Corker. You have talked about the stress test, and 
I guess I am--you know, the markets roil because they do not 
know really know what that means exactly. Can you expand a 
little bit so maybe for the first time we would be educated as 
to what that stress test is going to be comprised of?
    Mr. Bernanke. Yes. There will be more information, I 
believe, very soon, but let me give you my view of that.
    The assessment will look at the balance sheets and the 
capital needs of each of our 19 largest, $100 billion plus 
banks over the next 2-year horizon, under both a consensus 
forecast of where we think the economy is likely to be, based 
on private sector forecasts, and an alternative which is worse, 
that is, a more stressed situation. I should emphasize that the 
outcome of this test is not going to be, say, you pass, you 
fail. That is not the outcome. The outcome is going to be: Here 
is how much capital this institution needs to guarantee that it 
will have high-quality capital and to be well capitalized 
sufficient to be able to lend and to support the economy, even 
if the stress scenario arises.
    So the purpose of the test is to try to ensure that even in 
a bad scenario, banks will have enough capital, including 
enough common equity, to meet their obligations to lend.
    Senator Corker. So what I would take from that is, in 
earlier comments about--I guess our concern still is about 
systemic risk and that there are organizations and institutions 
that are too large to fail. That is what you said earlier. And 
so, if I am to understand this right, the stress test would 
simultaneously in many cases, my assumption would be, show 
there is a need for additional large amounts of capital; and 
what you are saying is you are going to solve that problem--I 
think what you are saying is you have a plan to solve that 
problem simultaneously.
    Mr. Bernanke. That is correct.
    Senator Corker. And we know that the private markets right 
now are not funding that, so I think this is pretty 
educational. Could you lay out how exactly that is going to 
occur? And then what is the term that we use to describe that? 
You know, there has been a lot of words that have been thrown 
around in the last week or so, again, that have concerned the 
markets. So when you find there is stress and when we 
simultaneously agree that we are going to put public dollars 
into these institutions, what is it that we call that?
    Mr. Bernanke. Providing sufficient capital to make sure 
that the banks in private hands can continue to provide the 
lending and liquidity needed for the economy to recover.
    If I might, Senator, if I may, the way this will be 
provided----
    Senator Corker. Well, let me ask you this: What is the role 
of the common shareholders at that point?
    Mr. Bernanke. The common shareholders will still have 
ownership shares and still be co-investors in the bank.
    Senator Corker. And they would be, I guess, hugely diluted 
under that scenario?
    Mr. Bernanke. Well, to the extent that there is more common 
put in, then depending on existing expectations and pricing, it 
may or may not affect the prices of the common. It depends on 
expectations where the price is today----
    Senator Corker. But I guess--and I know my time is up, and 
I think you know I have a great deal of respect and I 
appreciate the way the interaction has been. So, in essence, we 
have decided that there are a number of institutions in our 
country that are too large to fail. We are going to stress test 
them--and really, to me, it is not so much about capital. It is 
our ability to calculate risk in the past, and I think we are 
going to look at that risk in a much different way. And then 
simultaneous to that, as a Government entity, we are going to 
be providing capital to these institutions on a go-forward 
basis. And so the signal to us and to the markets--and I am 
just clarifying--is that there are institutions in this country 
that absolutely will not fail, and we will go to whatever 
lengths necessary with public sector dollars to ensure that 
that does not occur.
    Mr. Bernanke. Well, we are committed to ensuring the 
viability of all the major financial institutions. Fortunately, 
it does not come up in the sense that none of the major 
institutions are subject at this point to any kind of FIDICIA 
or prompt corrective action rules, so----
    Senator Corker. But they will be when these stress tests 
take place.
    Mr. Bernanke. No, I do not think so. Remember, we are 
looking not just at the main-line scenario; we are asking how 
much additional capital would be needed if you get this worse 
case, a stressed case. And it is important to add--Mr. 
Chairman, if I could have just a moment.
    Chairman Dodd. Please.
    Mr. Bernanke. That the way the capital we provided will be 
in the form of a convertible preferred stock, so this capital 
is available to the bank, but it does not have an ownership 
implication until such time as those losses which are forecast 
in the bad scenario actually occur. At that time, then the bank 
could convert the preferred to common to make sure it has 
sufficient common equity, and only at that time going forward, 
if those losses do occur, would the ownership implications 
become relevant.
    Senator Corker. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator. Very important set of 
questions. Thank you, Mr. Chairman, for your responses.
    Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    Thank you, Chairman Bernanke. Let me ask you, on page 7 of 
your testimony, you were talking about the economic outlook, 
and you said, ``Another risk derives from the destructive power 
of the so-called adverse feedback loop in which weakening 
economic and financial conditions become mutually 
reinforcing.'' And to break that loop, it is--these are your 
words--``essential that we continue to complement fiscal 
stimulus with strong Government action to stabilize financial 
institutions and financial markets.''
    My question is: Is what is already being done sufficient? 
Are those the strong actions that you are talking about, or is 
there more to be done? And do those actions require greater 
capital infusions? And if so, there are some who suggest that 
some of the major banks in the country already are somewhat in 
a frozen state because they may continue to lose significant 
amounts, and they are frozen. And what we ultimately want to 
see them do, which is lend into the marketplace. And if that is 
going to take even greater infusions of capital from the 
Government, at what point are we not ultimately being the 
entity that is running those banks?
    So give me a sense of what strong Government actions you 
are talking about here, because it is not about--I read your 
comments about it is not just simply about the financial 
institutions, it is about our economy as a whole that will 
depend upon whether or not these financial institutions are 
strengthened.
    Mr. Bernanke. Well, I think if the basic elements in the 
Treasury plan, supported by Federal Reserve actions of the type 
we discussed, our lending programs and so on, are effectively 
executed, patiently executed, that it will lead to 
stabilization of the financial system. We do not know exactly 
what the costs will be. It will be up to Treasury to make the 
determination. We will have to see how the economy evolves. We 
will have to see how the assessments evolve.
    But I think we need to follow through and understand that 
it is going to take a bit of time and certainly some resources 
to make sure that these institutions and markets are 
functioning again, because we all know--and we can see this in 
many, many other historical examples--that if the financial 
system is dysfunctional, the economy cannot recover.
    Senator Menendez. But isn't it true that, largely speaking, 
at least at this point in time, these banks cannot raise the 
type of private capital that they need? And if they cannot 
raise the private capital that they need and all we are doing 
is a flow and infusion of capital, wouldn't we be better off in 
getting to where we are going to have to get anyhow, to do it 
sooner rather than later? I think it will be less costly. We 
will begin to see the recovery a lot sooner. But it seems to me 
that we have a reticence to come forth to the American people 
and say, look, this is the true picture of the nature of what 
we face, and here is what it is going to cost. And at the end 
of the day, let's quantify that and then let's deal with it so 
that if we are going to have to get there by dribs and drabs at 
the end in a torturous process that will be increasingly more 
difficult politically, increasingly more difficult for the 
economy, and increasingly less likely to produce the turnaround 
as quickly as we would like to see, even understanding it is 
going to take time, isn't that really what we should be doing 
right now?
    Mr. Bernanke. Well, Senator, I think it is very important 
that we do our very best to assess the costs and the need for 
capital as accurately as we can, recognizing that since we do 
not know exactly how the economy is going to evolve and how the 
housing market is going to evolve, you cannot put an exact 
number on the value of a mortgage asset, for example, but we 
can do the best we can.
    I would like to address, I think, a perception that we are 
putting capital into the banks and we are letting them do 
whatever they want. That is absolutely not the case. First of 
all, the regulators are now very actively engaged, particularly 
with the more troubled institutions, working with them to 
restructure, to sell assets, to take whatever steps they need 
to be viable again and profitable again. We are not going to 
let them do what they want. We are going to be very, very 
vigilant and make sure that they are taking the tough decisions 
they need to get back to viability.
    Beyond that, we have the TARP, which also has its own set 
of rules and oversight, and beyond that, if the Government has 
some ownership rights, that also has an effect.
    Senator Menendez. So are you telling the Committee that 
what you have already--you collectively, the Federal Reserve, 
the administration, Treasury--what you have announced, if 
implemented well, will be sufficient to meet our challenge? Or 
are there other chapters yet to be had?
    Mr. Bernanke. Well, nobody's record in forecasting this 
thing has been particularly good, but I think that this----
    Senator Menendez. We are agreed on that.
    Mr. Bernanke. We are agreed on that. I think, as I said 
earlier to Senator Corker, that this program has all the major 
components, including tough supervisory and Government 
oversight, of previous successful financial stabilization 
plans. If it is well executed and forcefully executed, it is 
our best hope of stabilizing the system.
    Senator Menendez. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Senator Johanns.
    Senator Johanns. Thank you, Mr. Chairman.
    Chairman Bernanke, yesterday I had the privilege actually 
of reading the farewell address from George Washington on the 
Senate floor. And it is hard to read; it is kind of a tough 
read, so I spent some time with it. And one of the things 
President Washington warned the very young Nation about was 
debt and the calamity that that can create for a nation.
    I want to turn to page 23 of the document that we got today 
to talk to you a little bit about maybe a big-picture issue, 
and that is the national savings rate.
    According to this document, in the third quarter of 2008, 
net national savings stood at a negative 1.75 percent of the 
GDP. But this is what I found most alarming by this report. It 
goes on to say, ``National savings will likely remain low this 
year''--that is not very surprising--``in light of the weak 
economy and the recently enacted fiscal stimulus package. 
Nonetheless, if not boosted over the longer run, persistent low 
levels of national saving will be associated with low rates of 
capital formation, which is the engine that drives our economy, 
certainly in part, and heavy borrowing from abroad, which would 
limit the rise in the standard of living of U.S. residents over 
time and hamper the ability of the Nation to meet the 
retirement needs of an aging population.''
    I find those statements enormously concerning because what 
we are saying here is, with all that we are doing--and I agree 
with others. I think you are doing everything you can to try to 
get out in front of this problem. But all we are doing is 
borrowing money, borrowing money, TARP was financed with 
borrowed money, stimulus financed with borrowed money, national 
deficit will be $1 trillion or more this year, borrowed money, 
and it goes on and on and on.
    Tell me how we deal with that, because if we don't, I think 
what this report says is our children will suffer, and this 
aging population--baby boomers I think is what you are 
referring to--we may not be able to deal with their retirement. 
So give me the big picture here.
    Mr. Bernanke. Well, Senator, you are absolutely right. Your 
point is very well taken. The short story is that for the last 
decade or so, Americans have been made wealthy by either their 
stockholdings if they had a 401(k) or by the value of their 
house. And if the value of your home goes up, you feel richer, 
but you do not save more because you feel richer. Your house is 
saving for you in some sense. And as a result, over that 
period, as asset prices were rising, Americans saved less and 
borrowed more from abroad.
    Now, earlier Senator Dodd asked me about asset values. As 
those asset values have come down, that means there has been a 
very painful adjustment. People, in order to rebuild their 
balance sheets, are going to have to save again. And in a way, 
that is good because we will turn over the next few years to a 
higher rate of national saving, less foreign borrowing, lower 
current account deficits, and that is a desirable place to go.
    The transition, though, is very difficult because as people 
switch from being high-spending to trying to save, the decline 
in consumer spending has contributed to this great weakness in 
the economy, and we have a situation where instead of saving 
more, we are just getting a deeper and deeper recession.
    So we have currently an emergency situation that includes 
both a very severe recession and a significant financial 
crisis, which must be addressed or else we will not have the 
kind of growth we need to support saving and investment going 
forward.
    So we need to address that in the short term, but as we do 
that, we also have to keep a very close eye on the need to 
reestablish fiscal discipline, to increase Americans' savings, 
to reduce our current account deficit. And in doing all those 
things, over time we will be able better to address those 
issues that you referred to. But we are in the middle of a 
transition where, frankly, if we were to try to balance the 
Federal budget this year, it would be very contractionary and 
probably counterproductive.
    Chairman Dodd. Thank you, Senator, very much.
    Senator Bayh, you get a chance here. You were at the end of 
the line.
    Senator Bayh. Sneaking in under the wire.
    Chairman Dodd. Sneaking in under the wire. Have you voted 
yet, Senator?
    Senator Bayh. I have not.
    Chairman Dodd. I will let you decide whether or not you----
    Senator Bayh. I will, quickly.
    Mr. Chairman, my first question involves the importance of 
confidence in resolving the crisis that we face. It seems to me 
that an understanding of human psychology on both the 
individual and the group level is at least as important as 
quantitative analysis in getting this resolved. We have taken 
extraordinary action--you at the Fed, the Treasury, the 
Congress. We have tried to stabilize our financial 
institutions. We have moved to prop up consumer demand. We are 
trying to mitigate the adverse effects of home foreclosure. And 
yet confidence has not improved. As a matter of fact, very 
often the markets sell off the day that these programs are 
announced, suggesting that the public either does not have 
confidence in the solution or in our ability to implement the 
solution correctly.
    What will it take, in your opinion, to improve confidence 
and to improve the psychology that will be necessary to 
ultimately heading in a better direction?
    Mr. Bernanke. Well, I think ultimately the words are not 
enough to inspire confidence. You have to start to show 
results. So I think we have to have a bit of patience to see 
fiscal stimulus, to see the financial program.
    Senator Bayh. It is a bit of a dilemma, isn't it? The 
results are somewhat dependent on confidence, which, of course, 
is affected by results.
    Mr. Bernanke. That is right. But, nevertheless, I think as, 
say, the Federal Reserve's programs begin to open up some of 
our key credit markets--and we have--to give you an example, we 
have seen significant improvement in the commercial paper 
market, money market mutual funds, and some other areas where 
we have intervened. And those improvements have been sustained 
despite the general deterioration in the stock market and some 
other financial markets.
    So I think enough concerted effort and finding our way 
forward, history will perhaps put this whole episode into some 
context. It has been a very, very difficult episode. Obviously, 
many people have failed to anticipate all the twists and turns 
of this crisis. But it is an extraordinarily complex crisis, 
and being able to solve it immediately is really beyond human 
capacity.
    As we move forward, as we show commitment to solving the 
problem, as we take credible steps in that direction and we 
begin to see progress, I think the confidence will come back. 
And I agree with you 100 percent that a lot of this is 
confidence.
    Senator Bayh. So perhaps there is a lag between material 
improvement, albeit modest and gradual, and the popular 
appreciation of that improvement. There is some lag there 
before people have comprehended and, therefore, confidence----
    Mr. Bernanke. There well could be, yes.
    Senator Bayh. My second question involves the popular anger 
at the crisis that we face and some of the steps that have been 
proposed to deal with it, and it really gets to the dilemma 
between balancing the risk of contagion versus the risk of 
moral hazard. It has been said by some that some of the steps 
that we have taken to contain the damage in the aggregate have 
had the unintended consequence of absolving some individuals of 
mistakes that they have made in their individual capacity. This 
has been expressed by commentators on the financial shows and 
that sort of thing, and one this last week asked a question or 
basically made the statement: ``Our policies are rewarding bad 
behavior.''
    A lot of people feel that way who behaved in prudent 
fashion, who did not extend themselves. They were not working 
on Wall Street taking these enormous risks.
    What would you say to them when we seem to absolve the 
people who created the crisis from bearing its full effects?
    Mr. Bernanke. First of all, Senator, I hear that all the 
time, and I fully understand the sentiment. A lot of this goes 
against American values of self-reliance and responsibility. 
And I am very, very aware of that.
    I think I would give the following example: If your 
neighbor smokes in bed and sets his house afire, and you live 
in a neighborhood of closely packed wooden houses, you could 
punish him very severely by refusing to send the fire 
department, and then he would probably learn his lesson about 
smoking in bed. But, unfortunately, in the process you would 
have the entire neighborhood burning down.
    I think the smart way to deal with a situation like that is 
to put out the fire, save him from the consequences of his own 
action, but then going forward, enact penalties and set tougher 
rules about smoking in bed or the fire code or whatever it may 
be.
    So as we talk about these financial actions to the public, 
we have to say this is really a two-legged program. On the one 
hand, we are doing what we have to do now to prevent the 
economy from going into a deeper, protracted downturn 
associated with the financial crisis; but we have to commit, as 
part of this going forward, that we will do a substantial 
reform of financial regulation, that we will take all the steps 
necessary to make sure that this does not happen again and that 
the same situations do not arise in the future.
    Senator Bayh. Thank you, Chairman. I am going to need to 
run to vote. I have got 15 seconds left. The question I was 
going to ask, which I think Chairman Shelby raised in the 
course of his comments, it is going to take the wisdom of a 
Solomon to know when to change course on our current policies 
dealing with the crisis that we face, dealing with the longer-
run risk of inflation and so forth. I would be interested at 
some point in knowing what sort of metrics you will be looking 
at to assess when a recovery has achieved enough momentum to 
begin to then shift the policy. But a question for another day, 
and that would be a happy state of affairs to face.
    Mr. Bernanke. We have put extensive work into that, 
Senator.
    Senator Bayh. Thank you, Mr. Chairman.
    Senator Reed [presiding]. Senator Tester.
    Senator Tester. Thank you, Senator Reed.
    Thank you, Mr. Chairman, for being here. You have mentioned 
several times in your testimony and through some of the 
questions that you have answered about the global nature of 
this economic downturn. Could you give me any insight into what 
the European banks' status are? Is it similar, worse shape, and 
are all the skeletons out of their closets?
    Mr. Bernanke. Well, the stories that relate this purely to 
the United States have to account for the fact that the entire 
industrial world has suffered from this credit crisis and many 
banks in Europe and in the U.K. have taken very significant 
losses. The U.K., Irish, and Germans have been involved in some 
interventions. So I think it depends really country by country. 
I don't want to generalize and create any misperceptions.
    But it is obvious that there have been very significant 
problems in the European banking system, and they face some 
issues which we may not face to the same degree. For example, 
there has been recent concern about Eastern Europe and the 
exposure they may have in that direction. So they are 
contending with the same set of issues that we are here.
    Senator Tester. OK. And you made the statement several 
times that the only way we are going to get out of this is if 
our financial markets are healthy, to pull us out of this. What 
impact does Europe, and as far as that goes, the Pacific Rim 
have if they don't do anything or do far less than they need to 
do on our economy?
    Mr. Bernanke. Well, it will have impacts because of the 
interconnected nature of our global financial system and the 
interconnected nature of our global economy, as we depend on 
each other for trade and other terms.
    Senator Tester. Right.
    Mr. Bernanke. The Europeans have been somewhat more 
reluctant to engage in fiscal expansion than we have, although 
they have taken steps in that direction. The Germans, for 
example, after initially being disinclined, actually took a 
fairly significant step. But they are working also along 
similar lines as the United States to deal with bad assets, to 
deal with capitalization, and they are addressing many of the 
same situations.
    Senator Tester. Do we have the ability to get out of this 
financial situation if they don't make proper investments 
financially if they are in, regardless of what we do at this 
end?
    Mr. Bernanke. I think we can improve our situation. I will 
give you an example----
    Senator Tester. But can we get out of the situation?
    Mr. Bernanke. I think a complete recovery would require a 
global recovery and that would require----
    Senator Tester. Have you gotten any assurances from the 
banking markets that they are inclined to do that?
    Mr. Bernanke. Senator, they are very aware of the 
situation. I talk frequently with Europeans. We were just at 
the G-7, the Secretary and I, in Rome and we discussed all 
these issues----
    Senator Tester. Right.
    Mr. Bernanke. ----and they are quite interested in 
addressing them.
    Senator Tester. Injection of capital is something that we 
have been talking about now for 6 months or so. Can you give me 
any sort of prediction, under the assumption that Europe does 
what they need to do and the Asian markets do what they need to 
do, can you give me any sort of prediction on how much money it 
will cost, how much capital do we need to inject into the 
marketplace?
    Mr. Bernanke. Well, we have already done quite a bit.
    Senator Tester. Yes.
    Mr. Bernanke. We have done quite a bit. Honestly, Senator, 
I think it is not up to me to make that judgment. That is going 
to depend on the economy, on the scenarios, and on the amount 
of margin of safety that the decision is made to address. 
Ultimately the Treasury and the administration have to make 
that proposal.
    Senator Tester. OK. I would sure like your input on that, 
if that is possible. I mean, we are going to be talking about 
some--I mean, we have already directed some serious dollars and 
it is, from everything I am hearing, it is going to require 
some more. The worst thing that could happen is if we don't get 
cooperation from Europe, from Asia, we end up pumping a bunch 
of money in and then all it does is increase the debt. We don't 
get out of the situation we are in.
    Mr. Bernanke. I hear what you are saying.
    Senator Tester. OK. The other issue revolves around, just 
very quickly, the dollars that came from TARP, and Senator 
Bunning talked about for a little bit, you know, who is getting 
the money and where is it going to. Somebody pointed out to me 
in the banking industry that the banks aren't loaning this 
money out because they are using it to buy Treasury notes with, 
which is an interesting concept. Could you give me any insight 
into that? Is that what is occurring? Is that what they are 
doing with the TARP dollars?
    Mr. Bernanke. Senator, the direct impact of the TARP 
dollars is to expand the capital bases of these companies which 
allows them to do all the activities they do, including 
lending----
    Senator Tester. But the lending hasn't freed up, from 
everybody I have talked to.
    Mr. Bernanke. Well, a big part of that is the non-bank 
component, is the securitized markets, for example, which is 
what the Fed is working on right now. Let me just say that the 
Treasury's new proposal does involve more concentrated attempts 
to get banks to document how much they are lending, how much 
they would have lent without the TARP, and so on. It is a 
difficult problem, though, because you don't know what they 
would have done in the absence of the TARP money.
    Senator Tester. OK. Thank you very much, Mr. Chairman.
    Senator Reed. Senator Martinez.
    Senator Martinez. Thank you very much, Senator.
    Mr. Chairman, thank you for being with us and thank you for 
the terrific work that you are doing in very difficult stress 
circumstances.
    I wanted to ask about the housing market. You indicated 
that one of the things, and I agree with you, that we need in 
order to stabilize the entire situation in our economy is to 
stabilize the housing market and that it will help--I am not 
trying to paraphrase what you said, I may have said it wrong, 
but in any way, that it may help in the recovery.
    What additional steps can we undertake, in your estimation, 
that would help stabilize the housing market? I continue to be 
concerned by the rate of foreclosures. I welcome some of the 
ideas that the administration put forth last week. I continue 
to be concerned in places like Florida about a tremendous 
inventory of unsold homes that obviously needs to be drawn down 
before there will be vitality in the marketplace again. And 
obviously the same issues of credit continue to creep into the 
problem, particularly if we look at nonconforming loans and 
things of that nature. Any additional steps you think could or 
should be taken?
    Mr. Bernanke. Well, the two principal steps that are being 
taken, first, is the set of measures to try to reduce 
preventable foreclosures, which will reduce the supply of homes 
in the market and would be helpful to prices and construction.
    The other step has been the Federal Reserve's concerted 
efforts to lower mortgage rates by the purchase of GSE 
securities. We have had some success in that direction. So 
house prices are down quite a bit, obviously, and interest 
rates are pretty low. So affordability is not the issue it was 
a few years ago.
    So at this point, I would recommend focusing broadly on the 
economy and the financial system as a whole. People are not 
likely to buy houses when they are feeling very unsure about 
their jobs, for example. So the more we can do to strengthen 
the overall economy and stabilize the financial system, and 
along Senator Bayh's line, restore confidence, I think that 
will be the best thing to get the housing market going again.
    Senator Martinez. In December, the Federal Reserve reduced 
the fund rates further, and then obviously you noted on 
February 18 that widening credit spreads, more restrictive 
lending standards, and credit market dysfunction have all 
worked against the monetary easing and have led to tighter 
financial conditions overall. What other tools is the Fed 
employing to ease credit conditions and to support the broader 
economy?
    Mr. Bernanke. Senator, we have gone beyond interest rate 
policy to try to find new ways to ease credit markets, and I 
have talked about in some recent speeches and testimonies three 
general types of things we have done.
    The first is to make sure that there is plenty of liquidity 
available for banks and other financial institutions, not only 
in the United States, but around the world in dollars. So we 
have been lending to banks to make sure they have enough cash 
liquidity so they won't be afraid of loss of liquidity as they 
plan to make commitments on the credit side.
    Second, as I already indicated, we have been involved in 
purchasing GSE securities, which has brought down mortgage 
rates.
    The third group of activities encompasses a number of 
different programs which have been focused primarily on getting 
non-bank credit markets functioning again. We were involved, 
for example, in doing some backstop lending to try to stabilize 
the money market mutual funds and also to stabilize the 
commercial paper market, and we have had some success in 
bringing down commercial paper rates and commercial paper 
spreads and giving firms access to longer-term money than they 
were getting in September and October.
    Likewise, one of our biggest programs is just commencing 
now, which is an attempt to provide backstop support to the 
asset-backed securities market. That market is one where the 
financing for many of our most popular types of credit--auto 
loans, student loans, small business loans, credit card loans, 
all those things--have historically been financed through the 
asset-backed securities market. Those markets are largely shut 
down at this point. Through our TALF facility which is about to 
open, we, working with the Treasury, expect to get those 
markets going again and help provide new credit availability in 
those areas.
    So it is not just the banks. If we are going to get the 
credit system going again, we need to address the non-bank 
credit sources and we are aggressively looking at all the 
possible ways we can to do that.
    Senator Martinez. Speaking about the TALF and the credit 
facilities that have been opened, at some point, the concern 
shifts to what happens after a recovery begins to unfold in 
anticipation of perhaps in the latter part of this year, with 
some good fortune, and perhaps in the beginning of the next if 
not, that we will be in the recovery mode. At that point, how 
long will it take to phaseout those types of facilities like 
the TALF and what factors will determine the timing and the 
process by which you will do that?
    Mr. Bernanke. Senator, that is a very important question, 
the exit strategy. We have been spending a lot of time working 
on that. In order to be able to start raising interest rates 
again and going back to more normal monetary policy, we are 
going to have to bring down the size of our balance sheet. 
Fortunately, a very large part of our balance sheet, well over 
half of our lending, is in very short-term types of loans, 3 
months or even in some cases just a few days, so as the need 
for that credit weakens, is reduced by the strengthening 
economy, those programs will naturally tend to contract and the 
balance sheet will naturally tend to decline.
    So a lot of it will just happen as the economy strengthens, 
as the need for that credit dissipates, and in particular, 
since for many of the program we have created, the terms are 
somewhat more punitive than would be normal under normal 
circumstances, as the markets begin to normalize, then 
borrowers will tend to move away from the Fed facilities and 
into the private sector facilities. So we think that those 
markets, those programs will tend to contract on their own to 
some extent and we can always, of course, contract them 
ourselves as we determine that we need to reduce the size of 
the balance sheet.
    We have a number of other tools, and I don't want to take 
all your time, Senator, but just to give one example. In the 
EESA bill last October, the Congress gave the Fed the ability 
to pay interest on excess reserves, and our ability to do that 
will help us raise interest rates at the time it is needed even 
if the balance sheet is not all the way back down to where it 
was when we started this process. So we are very, very focused 
on making sure that we are able to normalize monetary 
conditions at the appropriate time. At the same time, we also 
don't want to give up opportunities where we think we can help 
the markets function better and provide some support for this 
economy.
    Senator Martinez. Thank you very much, Mr. Chairman.
    Senator Reed. Senator Kohl.
    Senator Kohl. Thank you very much.
    Chairman Bernanke, I am sure you have given this some 
thought and perhaps discussed it with many people down at the 
Federal Reserve. How much money do you think we will have to 
invest in our banks in order to make them stable and to resume 
their normal functions?
    Mr. Bernanke. Well, Senator, as I said to Senator Tester, 
we have already put in quite a bit. How much more we will have 
to do depends on the state of the banks. It depends on how the 
economy evolves. And it depends on the margin of safety we want 
to have. So I am afraid I can't give you a number. I am going 
to have to leave that to the Treasury and administration. They 
are going to have to come up with a view on what is needed. But 
obviously, I think we have already done quite a bit and it has 
been helpful. It has stabilized the system to some extent.
    Senator Kohl. One of the assessments that you make with 
respect to our recovery is based on the stimulus. How would you 
assess the stimulus in terms of its size, its priorities, the 
amount of money we are spending quickly? If you would have 
written it yourself, what are some of the things you might have 
done differently?
    Mr. Bernanke. Well, Senator, last October, in front of the 
House Budget Committee, I did indicate that given the weakness 
of the economy, given that the Federal Reserve was running out 
of space to lower interest rates, it was appropriate for 
Congress to consider a significant fiscal program. But I have 
deferred to Congress's prerogatives and not involved myself in 
adjudicating these elements which are obviously contentious.
    There is a tradeoff between the size of the program, the 
amount of debt that is incurred in the program, the efficiency 
of the spending. So it really depends a lot on Congress's 
judgments about how effective the spending will be, how quickly 
it can be put out. So I would prefer not to involve myself in 
that other than to say that I did agree and acknowledge that 
some substantial fiscal action was appropriate in helping get 
the economy moving again in the current environment.
    Senator Kohl. So you, in a general way, might have 
supported the stimulus plan that we finally passed?
    Mr. Bernanke. I supported a substantial fiscal program, but 
I recognize the legitimate disputes and controversies about the 
size and the composition and the like and I, frankly, don't 
feel that it is my place in my particular role to try to 
intervene on that.
    Senator Kohl. Sure. Chairman Bernanke, one of the biggest 
reasons that we got into such a difficult situation obviously 
is the home buyers, the mortgage mess, and the loans that they 
were receiving that they could not afford from unsupervised 
lenders, and most of these lenders were overseen at the State 
level. In 2008, the Federal Reserve finalized rules to better 
protect home buyers from unfair and deceptive practices in the 
mortgage market which will take effect in October of this year.
    While these new rules will apply to all mortgage lenders, 
those who are not routinely subject to Federal oversight might 
not adhere to the new rules closely enough to make them, in 
effect, work. So what steps is the Federal Reserve taking to 
ensure full understanding and compliance with the new 
regulations by mortgage lenders which are not routinely 
examined by Federal regulators?
    Mr. Bernanke. Well, Senator, we have a mismatch of the 
regulatory authority and the enforcement authority, as you 
point out, and we have worked hard to try to address that. The 
Federal Reserve has a very good relationship, for example, with 
the Conference of State Bank Supervisors, which brings together 
bank supervisors from around the country. We have engaged in a 
number of outreach efforts to work with them, and we have also 
conducted joint examinations with the State bank supervisors 
and other State authorities to provide each other information 
on how we go about our own assessments and try and establish 
some degree of consistency across State and Federal oversight.
    So we are doing as much as we can to try to increase the 
cooperation and communication between the Federal Reserve and 
the various State regulators. Having said that, it is certainly 
inevitable that some States will put more resources and effort 
and personnel into these oversight functions than others and so 
there is inevitably going to be a certain amount of unevenness 
in oversight. But we are doing what we can to work with the 
State authorities as best we can.
    Senator Kohl. But you would agree that, going forward, it 
is critical that we have this kind of oversight, and regulatory 
oversight, it was the lack of it that created the mess that we 
are in right now?
    Mr. Bernanke. Well, it is by no means the only factor. 
There are plenty of things that went wrong. But it was 
certainly one factor, and as we look at regulatory reform, we 
need to ask the question, are all the sectors of the economy 
that need oversight, are they being watched by somebody or are 
there major gaps where there is no effective oversight where 
there needs to be, and that is, I think, a very basic aspect of 
the reform that Congress needs to address.
    Senator Kohl. Thank you. Thank you, Mr. Chairman.
    Chairman Dodd [presiding]. Thank you very much, Senator.
    Senator Hutchison.
    Senator Hutchison. Thank you, Mr. Chairman and Mr. 
Chairman.
    I want to go back to the inflation threat, which I think 
today and also previously you have said that it is not a worry, 
that half of your obligations are short-term. But I am looking 
at the overall picture, where some economists are beginning to 
look at the $10.6 trillion debt that we have plus last week's 
stimulus, or 2 weeks' ago stimulus with interest is another 
trillion, and starting to look at the tipping point. Twenty-
five percent of our debt is held by foreign entities. What if 
they start saying, hey, this risk is too high and they want a 
higher interest rate? That, on top of half of your obligations 
being somewhat long-term.
    Are you concerned in looking at the overall picture about 
the possibility of inflation and what could you do to keep that 
from happening through any kind of policy, because obviously 
that would be a devastating turn for our country.
    Mr. Bernanke. Well, inflation is primarily the 
responsibility of the Federal Reserve and we consider that to 
be a critical element of our mandate. Our view is that over the 
next couple of years, inflation, if anything, is going to be 
lower than normal, given how much commodity prices have come 
down, given how much slack there is in the economy. When the 
economy begins to recover, it is important that we raise 
interest rates and do what is necessary to prevent an 
overheating that would lead to inflation down the road, and as 
I have mentioned, we are confident that we can do that. Every 
time we use our balance sheet to try to support the economy, we 
are thinking about how can we unwind that in a way that will be 
kindly and allow us to take the actions we need to take.
    That is a somewhat separate issue from the debt issue. It 
seems to be, at least for now, that the dollar and U.S. debt 
are still very attractive around the world and there is a lot 
of demand for holding our Treasuries. That said, it is self-
evident that we can't run trillion-dollar deficits 
indefinitely. It is going to be very important, as we emerge 
from the crisis and begin to go into a recovery stage, that we 
get control of the fiscal situation and begin to bring down the 
deficit to a sustainable level.
    So I agree with you that we do need to address that issue. 
For the moment, foreign demand for U.S. securities is strong, 
but you are absolutely right. If we don't get control of it, 
eventually, they are going to lose confidence.
    Senator Hutchison. Let me shift to the issue that many of 
us have talked about and that is getting credit into the 
marketplace. Because the balance sheet of the banks has gone up 
so much now, holding their reserves in the Fed, and you are 
still paying interest to the banks, do you think that is having 
an impact on banks leaving their money in the Fed to get 
interest and having the reverse effect on what we all want, 
which is getting credit out into the marketplace?
    Mr. Bernanke. No, Senator. I don't think it works that way. 
If you like, one way of thinking about what is happening is 
that the banks are nervous about lending given their concerns 
about their own capital positions and about risk aversion and 
credit issues in the marketplace. So in a way, what the Fed is 
doing is borrowing by paying interest on reserves to the banks, 
and that is where we get the money, and then we are standing in 
between the banks and the marketplace, using that money, 
recycling it into commercial paper, asset-backed securities, 
and other forms of credit. So in a way, we are becoming the 
counterparty between the markets and the banks.
    Right now, we are paying one-fourth of 1 percent interest 
on reserves. When banks feel they have any kind of good 
opportunity to invest at better than one-fourth of 1 percent, 
they will. That will begin to create expansion in credit and 
money supply and will be the signal for the Fed to begin to 
pull back. But right now, it is clear that the banks are more 
willing to hold reserves at one-quarter of 1 percent than they 
are to make loans, so therefore we are stepping in to try to 
stimulate credit markets.
    Senator Hutchison. Let me just ask you, then, what 
practical advice would you give us to try to help get that 
credit out into the marketplace, because no matter what we say 
in Washington, go visit any person in a small business or 
medium-sized business that is trying to get credit for their 
business and they say it is impossible.
    Mr. Bernanke. That is why the economy is under such 
pressure. Absolutely. There is--it is useful to think about 
credit as coming from two places, the banks and then the non-
bank sources like asset-backed securities and commercial paper.
    On the banking side, our objectives, for example, working 
with the Treasury, are to try to stabilize the banking system, 
make sure they have enough capital to lend, and make sure they 
have enough liquidity. In addition, as part of our supervisory 
oversight, we want to make sure there is an appropriate balance 
between caution, which is critical--banks need to be cautious 
in their loans--but on the other hand, we want to make sure 
that they make loans to credit-worthy borrowers and are not 
turning down good borrowers because their regulator told them 
they can't make a loan. We don't want that to happen. We know 
sometimes it does happen, so we are trying hard to tell our 
examiners if the bank has a good loan to make and it is a good 
customer, let them make that loan. We want that to happen. So 
that is the banking side.
    On the non-bank side, again, it is a difficult problem, but 
the Fed is doing its best to work through some of these markets 
together with the Treasury to try to get credit flowing again 
through asset-backed securities markets and other types of non-
bank markets.
    Senator Hutchison. My time is up. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Senator Warner.
    Senator Warner. Thank you, Mr. Chairman, and thank you, 
Chairman Bernanke, for your comments this morning.
    I have got two areas I would like to press on. One is that 
we talk about the stress test process, and I was happy to hear 
this morning a little more clarity on that. I understand you 
are talking about now 19 banks. I have heard 14 banks, 20 
banks, 19 banks. I think the sooner we lay out to us and the 
markets which banks are actually going to go through this 
stress test so that we can make clear that there are hosts of 
many community-based banks and local banks recognizing it is 
not your regulatory oversight for these smaller banks, that 
these banks are still healthy and in good shape, I think we 
take an important step forward, at least to the markets, 
because in my State and I know so many of my colleagues' 
States, our local-based banks are getting drubbed down by this 
overall tower that is hanging over the industry at large.
    But as we go through this stress test, I guess you in some 
of the press reports yesterday gave us a little more clarity, 
but it seems like you are going to do a stress test that is 
going to say, if conditions get worse, will these banks have 
adequate capital. But that presumes, I suppose, that you are 
going to accept the banks' current recognition of what bad 
assets they may have and how they are marking them on their 
current balance sheets. You are not going to go in--I tried to 
press Secretary Geithner a little bit on this--you are not 
going to go in in the stress test and try to evaluate the so-
called toxic assets or put a pricing on them.
    Mr. Bernanke. We are going to evaluate them but according 
to the accepted accounting principles. So there are two classes 
of assets, broadly speaking, the mark-to-market assets, and we 
try to evaluate whether they are using appropriate models or 
information to do that. There is also banking broker accrual 
assets, which banks don't have to mark to market because they 
are holding them to maturity. They do have to recognize credit 
losses and the like. We want to make sure that they are 
applying the right GAAP procedures there, and we are going to 
be looking not just at 1 year ahead, but 2 years ahead. The 
usual practices focus on the first year, but we want to make 
sure that even 2 years ahead, they are looking at projected 
losses and taking that into account.
    So we are going to be doing, as we always do, examinations 
based on Generally Accepted Accounting Principles, and we are 
not allowing the banks to hide anything or not provide adequate 
information. Indeed, we are going to make a special effort to 
coordinate among the supervisory agencies to make sure as much 
as possible that we have consistency across banks so there 
won't be any view that some banks are laggards and others are 
leaders in terms of writing down appropriate assets. We want to 
get a clear estimate of the capital needs.
    And the way we want to address the stress scenario is, 
again, by providing this convertible capital which starts off 
as preferred. It is in the bank, but only if the losses 
actually materialize that we are projecting and that capital 
gets eaten into will they need to make the conversion from 
preferred to common so to ensure that even in this bad scenario 
they have both enough capital to meet well-capitalized 
standards, but also enough common equity to meet high-quality 
standards that enough of their Tier I capital is in common.
    Senator Warner. If I understand you correctly, you are 
saying these banks that through the potential of falling below 
their minimum capital requirements will require some additional 
infusion. This additional infusion, you are assuming, would be 
entirely public funds that would be in this preferred position, 
correct? Is that correct?
    Mr. Bernanke. Preferred, but convertible to common.
    Senator Warner. Convertible. But the other piece of the 
program that Secretary Geithner outlined, which was the effort 
to try to get a public-private partnership of some level of 
private capital in here to help us, in effect, price some of 
these bad assets and buy them out, you don't think the stress 
test will divide the line between those banks that are going to 
get public capital and those banks that are going to end up 
falling into this public-private purchase program?
    Mr. Bernanke. So if the public-private program, which will 
take a bit of time to get up and running, works well, it will 
improve the situations of some banks by removing bad assets 
from their balance sheets. We are not taking that into account 
at this stage because we don't know exactly what effect that 
will have.
    Senator Warner. So the bank will be----
    Mr. Bernanke. So we are going to look at the current 
balance sheets as we do that evaluation.
    Senator Warner. And the bank will then have, in effect, two 
options. It can either unload some of its assets to this 
public-private purchasing entity or----
    Mr. Bernanke. We will start with the capital. If it turns 
out that the bank, because of good economic outcomes or because 
they are able to sell assets, doesn't need all the capital we 
gave them, then they can pay it back eventually.
    Senator Warner. I know my time is up. Can I ask one more 
quick question, though? I was happy to see yesterday your Web 
site and some of your comments this morning about more 
transparency, but one of the things, Dr. Elmendorf was in 
recently and did a pretty good outline of all of the various 
initiatives that have been started, and we realize you are 
fighting multiple fires on multiple fronts, but my count was 
there are eight new initiatives that the Fed has started since 
last fall.
    You have made investments or potential investments in four 
separate institutions, as some of my colleagues mentioned, 
increased the balance sheet by about a trillion dollars with 
the potential of going up to $4 trillion. Some of these are 
clearly purchasing of normal Treasury securities, but there is 
a whole series of new areas where you are taking on assets, AIG 
in particular and others, where the role of the Fed seems to be 
evolving into not only monetary policy and regulatory 
oversight, but more and more a holder of debt or equities in a 
series of institutions.
    Do you have the capabilities inside the institution to play 
this role, and looking back on the Bear Stearns when it looked 
like we had to bring in what at that point, now in retrospect 
$29 billion looks like a fairly minor challenge, but now with 
this potential of a trillion dollars added to your balance 
sheet, the potential of going to $4 trillion, how do you have 
the capabilities to manage all these assets inside the Fed?
    Mr. Bernanke. Senator, I want to make a very clear 
distinction between our programs that address broad credit 
markets--like asset-backed securities and commercial paper--and 
the rescue efforts we were involved for a couple of large 
firms. Those rescue efforts make up about 5 percent of our 
balance sheet. We got involved in them, frankly, because there 
is no clear resolution authority, in the United States for 
dealing with systemically critical failing institutions except 
for banks. But in the case of an investment bank or an 
insurance company, for example, there is no such regime, and we 
and the Treasury believe that if we allowed those institutions 
to fail, it would have done enormous damage to the world 
financial system and to the world economy.
    So we did what we had to do. We were very unhappy about 
doing it. We do not want to do it anymore. We would be 
delighted if the Congress would pass a substantial resolution 
regime that would create a set of rules and expectations for 
how you deal with a firm of this type that is failing and leave 
the central bank out of it entirely. So I hope very much that 
it will happen as you----
    Senator Warner. And I do not think I am--at least my intent 
is not to be critical, and I know the Chairman has the 
intention to pass legislation about it. But you still have 
these assets that you have got to manage in this ensuing time.
    Mr. Bernanke. Yes.
    Senator Warner. Do you have the capabilities to----
    Mr. Bernanke. We do. We do, and we have hired private 
sector firms as needed to manage----
    Senator Warner. I would like to see some more information 
on that.
    Thank you, Mr. Chairman.
    Chairman Dodd. Before I turn to Senator Merkley, I was just 
going over the--this is a form that has forms of Federal 
Reserve lending to financial institutions. I count 15 of them, 
12 of which have been started since August of--the earliest was 
August of 2007, most of them in 2008. So it is a rather 
elaborate chart and sort of daunting as well, from my point of 
view.
    Senator Merkley.
    Senator Merkley. Thank you, Mr. Chair, and thank you, Mr. 
Bernanke, for your testimony.
    A year ago, March 4 a year ago, you were giving a speech to 
bankers primarily about the challenges we face in the mortgage 
world, and you called for very vigorous response. You called 
for lenders to pursue aggressively renegotiation of loans. You 
also in that speech pointed out some of the challenges that 
exist to renegotiation. Those challenges included the fractured 
ownership of mortgages and the potential for lawsuits from 
those who owned different cash-flows, the fact that ownership 
trusts vary in the type and scope of modifications they are 
legally permitted to make. And in addition to your points that 
you made, there has been a lot of discussion of the fact that 
in general, when we start looking at the number of borrowers 
all seeking renegotiation at the same time, that lenders are 
ill equipped with the kind of trained workforce to be able to 
pursue those negotiations.
    In fact, I held a foreclosure mitigation workshop out in 
Oregon last week, and the single message that came through was 
the enormous frustration of homeowners trying to get in contact 
with anyone who could actually have the authority to talk to 
them about renegotiating their loan.
    My concern has been that these obstacles are worse now than 
a year ago and that they remain a significant obstacle to date 
of the type of strategy that we are pursuing that is embedded 
in the plan that the Treasury Secretary put out last week.
    Could you just comment on how you see the evolution of 
these obstacles, whether we can overcome them?
    Mr. Bernanke. Well, securitization remains a severe 
problem. The one element of the administration proposal which 
could address potentially both of the issues is the fact that 
they propose bounties or payments to the servicers who 
renegotiate loans. That aligns better their incentives with the 
incentives of the borrower in the sense that, without that, 
they do not necessarily have the incentive to try to get a 
better arrangement for the borrower. And, second, it gives them 
the funding to provide the manpower to go out and get in touch 
with the borrowers, work with them, and so on. So that is one 
element that may help on that side.
    There has been some progress in terms of accounting 
verifications and the like about getting loans out of MBS, and 
to the extent that MBS are being acquired more and more by 
Government agencies, we are working now toward a uniform 
renegotiation and protocol for all mortgages held by Fannie and 
Freddie and by the Fed or any other Treasury or any other 
Government-related body.
    But that still remains a problem, the existence of the 
securitization trust and the restrictions they place on when 
you can renegotiate a loan.
    Senator Merkley. Thank you. And I do hope those incentives 
and perhaps also the club that was laid out in the President's 
plan could be helpful, that club being the possibility of 
bankruptcy judges to be able to renegotiate the terms.
    In your speech, you also laid out the refinancing option as 
another strategy, and I keep wondering if indeed we are not 
able to--if we do not make progress, significant progress on 
the loan-by-loan modification, the different type of class 
actions, if you will--not lawsuits in this sense, but 
addressing the problem systematically. And you laid out one 
such idea, which was the Hope Now Alliance's potential freeze 
on subprime loans at the introductory rate, keeping that frozen 
for 5 years.
    Yesterday, I was up on Wall Street, and a banker was saying 
another strategy would be--a very bold strategy would be for 
the U.S. Government to guarantee essentially every home loan in 
America, and the basic math was $10 trillion, 10-percent 
failure, it is $1 trillion, you lose 50 percent on each 
transaction, so it is half a trillion dollars. But it is not 
only helping the homeowners, it is reinforcing--it is setting--
kind of restoring a foundation, if you will, for the 
derivatives related to those loans and, therefore, also 
compensation not just for the mortgage strategy, but also the 
strategy to reinforce our financial institutions.
    Any thoughts about that kind of action?
    Mr. Bernanke. Well, obviously, as your calculations 
suggest, it could be extremely costly, particularly if--and I 
hate to say it, but there might be some people who would say, 
well, if I am guaranteed anyway I will not lose my house, why 
don't I stop paying my mortgage? Unfortunately, that might be 
in some cases the response.
    That seems to me to be a very costly way to go about doing 
it. I think you are better off, for example, by the 
administration plan and other plans, like Sheila Bair's FDIC 
plan, which is closely related, which focuses not on every 
mortgage but looks at people according to their 
characteristics. So, for example, in the administration plan, 
you start with people who have very high ratios of payments to 
incomes, and then you try to get those down to, say, 31 
percent, which is a more sustainable level.
    So you are better off focusing on subpopulations where 
there is obviously a lot of stress, and that would probably be 
a more cost-effective way to get improvements in the 
foreclosure rate.
    Senator Merkley. Well, other strategies--I believe my time 
has expired. I will just leave you with a thought, which is 
that we need to continue to think about if the loan-by-loan 
modification approach simply cannot handle the volume of change 
that we need, what group strategies are worthy of 
consideration?
    Thank you.
    Chairman Dodd. Senator Bennet.
    Senator Bennet. Thank you, Mr. Chairman. Chairman Bernanke, 
thank you for your testimony and endurance here today. It is 
getting to me.
    I appreciate your comments about the commercial paper 
market because I think that was a place where the intervention 
seemed to be pretty effective, and I wanted to use my time to 
do a couple things today. One was to mention the crisis at our 
local governments and our public-oriented nonprofits like 
schools and hospitals are facing. As you know, that is an 
enormous segment of our economy, $2 trillion of shovel-ready 
projects, and with real capacity to help spur this recovery, I 
think. Those markets also are locked down. They are frozen, 
just as many of the other credit markets area. The markets for 
short-term auction rate and variable rate bonds have been 
particularly hard hit, and a lack of liquidity, which, as I 
said, is a problem plaguing all segments of the market, has 
stymied the local bond market, too. And banks receiving TARP 
money, nevertheless, have remained on the sidelines, unwilling 
to venture back into the local bond market. The variable-rate 
market is frozen. To borrow from the statute that empowers the 
Fed, the lack of liquidity results from the unusual and exigent 
circumstances facing financial institutions.
    It seems to me that the Fed could make an enormous 
difference by providing temporary support for liquidity in 
these markets just as it did in the commercial paper market 
that you mentioned earlier. In those case, those issuers happen 
to be taxpayers of States and localities, and the corporations 
happen to be public, not private. I do not know why we should 
restrict ourselves to cases of private investors but not also 
help local schools and hospitals in Colorado and across the 
Nation.
    This is not a matter of making loans to State and local 
governments. I am asking your consideration to supporting 
regulated financial institutions in cases where their letters 
of credit or other obligations provide liquidity to our 
financial markets, markets in this case which happen to involve 
State and local governments.
    So I wonder if you have got any thoughts about that piece 
of our economy.
    Mr. Bernanke. Well, the auction rate securities market is 
pretty much defunct. It was a class of markets that were 
essentially trying to finance long-term credit with short-term 
borrowing, and the appetite of investors for those kinds of 
markets has greatly diminished. So that particularly 
attractive, relatively cheap form of credit for States and 
localities has largely dried up, as you correctly point out. 
The State and local bond market in general still remains 
strained. It has improved somewhat, and we are watching that 
very carefully.
    I am not quite sure I follow the issue on banks. Going back 
to my earlier comment to Senator Hutchison, we certainly want 
to encourage banks to make loans to creditworthy borrowers 
wherever that is consistent with safety and soundness. That 
would include, of course, States and localities.
    From the Fed's perspective, there are a couple of reasons 
why we have not prioritized those markets with commercial 
paper. For example, we do, in fact, have a capacity constraint, 
which, as I discussed with Senator Hutchison and Senator 
Bunning and others, is the need for us to unwind our portfolio 
at an appropriate time. And so we cannot expand, particularly 
for longer-term liabilities, indefinitely. And in looking at 
various areas where we thought we could be helpful, for 
technical reasons first we thought we could do more, say, in 
the commercial paper market but, in addition, two other 
reasons.
    One is that the Congress obviously has been very involved 
in addressing State and local fiscal issues, including in the 
recent fiscal package, and it seems more appropriate, given the 
close relationship between the Federal and State governments, 
for that to be the locus of addressing those issues.
    And the other point I would make is that our extraordinary 
authority which we have invoked to make these loans, say, in 
the commercial paper market, does not include States and 
localities. So it would take some stretch beyond, I think, 
congressional intent to include them in some of these programs.
    But we understand the issue, and we are obviously paying 
very close attention to it, because, as you correctly point 
out, the inability of States and localities to finance 
themselves is having a direct impact on the services they 
provide and on the economy.
    Senator Bennet. Then if I could just say on that--and I 
want to see if the Chairman will let me ask my other question 
as well--it just seems like such a tough case, because there is 
no issue with the underlying credit here, unlike in some of the 
other things that we are talking about. It is purely the 
consequence of the loss of liquidity in the market. And at a 
time when we are spending, you know, $800 billion from here to 
do these shovel-ready projects, it would seem that if there 
were a way to create an environment, some sort of backstop of 
some kind to be able to get these governments in a position to 
be able to do the work they are intending to do anyway, with 
balance sheets and credit ratings that we know are good, that 
seems to me to be a really lost opportunity to leverage what we 
are doing here, which is the only reason I raise it.
    The second question I had, Mr. Chairman, if--I have got a 
couple seconds left.
    Chairman Dodd. As quick as you can, Senator.
    Senator Bennet. Very quick. You talked about how critical 
it was to stabilize the financial institutions as a way of 
getting our market going, and which everybody here agrees with. 
Can you give us some thoughts about how to ensure that the 
right level of rigor is applied to make sure that we really are 
valuing these assets and liabilities in a way that does not 
create a stasis where we are stuck in this for many years 
because we have not done an honest assessment of where things 
really are?
    Mr. Bernanke. That is very, very important. We learned from 
other examples that you need to figure out what these assets 
are worth. The supervisory efforts are using all our tools to 
get good valuations, but in this respect, I think the idea of 
using a public-private partnership in an asset purchase 
facility is potentially appealing. If you set up a program 
where both private sector investors and the public purse 
contribute capital to a facility, and then the purchases and 
pricing are done by private sector investors who are interested 
in making a profit, then there is a much better reason to think 
that the prices that come out will reflect true market 
realities rather than accounting fictions. So that is one 
reason to try to involve the private sector in this asset 
purchase program.
    But it is a very hard problem, and as I said earlier, it is 
not just a question of going in and saying this is the truth. 
Because the fact is that a mortgage could be worth X today, and 
then tomorrow you get news about the housing sector then maybe 
it is only worth 0.9X. So it is more difficult than just coming 
clean. It is really trying to make judgments about the whole 
future of the economy and the housing market as you try to 
assess the value of a given piece of paper.
    Senator Bennet. Thank you.
    Chairman Dodd. Thank you, Senator.
    Mr. Chairman, before I just turn to Senator Brown, on the 
major question--the first question raised by Senator Bennet, 
Senator Warner has done a lot of work on this as well, on this 
whole issue involving municipal bonds and AAA-rated where you 
are talking about investors, and the purchasing of those by the 
TALF, we are doing floor plans for cars, we are doing student 
loans. It seems to me AAA-rated bonds out of municipalities for 
schools and hospitals has got to be at least as creditworthy as 
a student loan, with all due respect to students and the car 
plan, the floor plan for cars.
    I would like to recommend, if we could, that Senator Bennet 
and Senator Warner--there are others who are interested--maybe 
could spend some time with you or your staff to talk about 
this, because I think we did give the congressional authority 
to that. As the Chairman of the Committee--and I joined them in 
their letter they sent down, and I believe the authority exists 
under the Congress for you to be able to do that under TALF 
with municipal issues.
    Now, that is my opinion. That is not a deciding opinion, 
but that is my conclusion, and I would be appreciative if some 
people could maybe sit from the Federal Reserve and talk to 
these Senators about this idea and explore it further if we 
could.
    Mr. Bernanke. Senator, if I may, of course, the TALF is a 
joint Federal Reserve Treasury program.
    Chairman Dodd. We will involve the Treasury.
    Mr. Bernanke. They would need to be involved in any kind of 
discussion.
    Chairman Dodd. We will involve the Treasury as well. I 
think it is just worthy--they came to me with the idea, and it 
made all the sense in the world to me, and I would like to see 
us possibly pursue that.
    Senator Brown.
    Senator Brown. Thank you, and, Chairman Bernanke, thank 
you.
    Let me share what I think is one of the most dramatic 
measures of our economy. Twenty years ago, in 1987--these 
numbers are 1987 and 2007. In 1987, manufacturing made up 17.1 
percent of our GDP; financial services made up 5.6 percent. In 
2007, manufacturing made up 11.7 percent, and financial 
services, 8 percent, before all the meltdown. So manufacturing, 
the percent of GDP--granted that GDP grew hugely in those 20 
years, but the percent of GDP, manufacturing dropped by about a 
third, and financial services went up about 40 percent, 
roughly.
    We spend a lot of time talking about the financial services 
industry, as we should. Manufacturing seems to be relatively 
ignored--not so much certainly in these discussions, not as 
important, but generally in Government policy. Talk to me, if 
you would, as we talk about reviving the credit markets, how 
much focus we should bring to credit markets to help the auto 
industry, whether it is individual car buyers, whether it is 
for the dealers, and then perhaps more broadly, your comments 
on manufacturing generally as our economy shifts in the years 
ahead.
    Mr. Bernanke. Well, the auto companies have obviously a 
number of issues, long-term structural issues and the like, but 
part of the----
    Senator Brown. I am talking more on the demand side here, 
on the demand side for buyers.
    Mr. Bernanke. Right. I was just going to say that part of 
the problems recently have to do with the credit markets and 
demand, and we have tried to address that. First, you know, our 
program in the commercial paper market has tried to improve 
financing for companies. Even though we lend only to the 
highest-rated companies, even the lower-rated companies have 
seen their rates come down quite considerably, and that also 
relates to our interest rate policy.
    In our Asset-Backed Securities program, as Chairman Dodd 
was just noting, among the things that we are allowing in the 
ABS program are auto loans, which has been an issue, and floor 
plans and RVs, things related to the demand for automobile 
production.
    So to the extent that credit markets are the problem, we 
are doing our best to try to address those and to lower 
interest rates. As Senator Dodd also mentioned, traditionally 
autos respond well to low interest rates. Obviously, there are 
a lot of other issues right now affecting the demand for autos.
    I think on the issue of manufacturing, in general, you do 
not want to set specific percentage targets for different 
industries. Obviously, there is an international division of 
labor which takes place over time, and different industries 
migrate to different parts of the world, depending on the 
relative complements of labor and capital in each area. But I 
think it may be that part of the impact on our manufacturing 
has been the trade deficit, which has been associated with a 
reduction in manufacturing because trade is very much conducted 
in manufacturing. So the movement in the trade deficit has been 
associated with greater imports of manufacturing, and that to 
some extent has been a competitive issue. And I realize that I 
am going to contradict myself here, but on the other hand, we 
should not put U.S. manufacturing down. It has actually had a 
pretty good performance overall. Productivity gains in U.S. 
manufacturing have been quite extraordinary over the last 10 
years. And, in fact, that is part of the reason why 
manufacturing employment has been so weak. It is that even as 
output stays more or less stable, the number of workers needed 
to produce that output has gone down.
    So in the short term, we are doing what we can to improve 
credit markets to help support autos and other industries. In 
the longer term, relating back to Senator Hutchison and others, 
if we have a better saving rate and more balanced trade flows, 
that may redound to some extent to the benefit of U.S. 
manufacturing. But in many States--Senator Tester was here. I 
have been to Montana and seen some of their manufacturing 
innovations. U.S. manufacturing has in many cases filled high-
level niches, very sophisticated niches, and very high-value 
production. So I would not write U.S. manufacturing off. There 
is a lot of value there. But clearly there are a lot of 
challenges as well.
    Senator Brown. I would make the case--and then one real 
quick question after that--that manufacturing, while 
productivity has gone up immensely in the last many years in 
manufacturing, wages have not kept pace with that productivity, 
which is the first time we have seen that disconnect, at least 
since your writing on the Great Depression--which, speaking of 
that, all--and I will not ask you a question about--this is 
just--well, listen to a quick comment about this. All my life I 
have sort of--when I have read about Roosevelt and the New 
Deal, there is almost unanimity, almost consensus from darn 
near everybody, that most of what Roosevelt did worked, the 
regulatory structure, the Government spending, and all that. 
Only in the last few months has it become so politicized and we 
have seen some revisionism in our history that Roosevelt and 
the New Deal were failures. I mean, it has come from some 
newspaper columnists, some pundits, some ideologues.
    Specifically what worked that Roosevelt did? What did we 
learn from that? What worked that applies to now?
    Mr. Bernanke. Well, there were two things that he did 
within months of taking office that were extremely important. 
One was the bank holiday and subsequent measures like the 
deposit insurance program that stabilized the banking system. 
This is a point I have been making all morning, that we need to 
stabilize the banks. The second thing he did was to take the 
U.S. off the gold standard, which allowed the Federal Reserve 
to ease monetary policy, allowed for a rise in prices, which, 
after 3 years of horrible deflation, allowed for recovery. So 
those were the two perhaps most important measures that he 
took.
    He did some counterproductive things, like the National 
Recovery Act, which put the floors under prices and wages and 
prevented necessary adjustment. The most controversial issue 
recently, of course, has been fiscal policy, and I think there 
are two sides to that. The classic work on this by an old 
teacher of mine from MIT, E. Cary Brown, said that fiscal 
policy under Roosevelt was not successful but only because it 
was not tried, and he argued that it was not big enough 
relative to the size of the problem. Other writers have argued 
that this was not the right medicine. So that one is more 
controversial, but if you asked me what I think the most 
important things were, I think they had to do with stabilizing 
monetary policy and stabilizing the financial system.
    Chairman Dodd. Maybe what we ought to do with the Committee 
sometime is maybe have just an informal dinner one night with 
interested Members and have a discussion about those days. I 
think it would be an interesting conversation.
    Senator Akaka.
    Senator Akaka. Thank you very much, Mr. Chairman.
    Welcome, Chairman Bernanke. It is good to see you. I can 
recall back on September 23, 2008, when we had a Banking 
meeting with four of you: Treasury Secretary Paulson, Cox, and 
you, and also with Jim Lockhart. At that time we were trying to 
learn what the crisis was all about and what we were going to 
do about it. And as I recall, we came out--really, what came 
out of it was the $700 billion was to bring confidence to Wall 
Street. But since then, many things have happened, and well 
before the current economic crisis, the financial regulatory 
system was failing to adequately protect working families from 
predatory practices and exploitation.
    Families were being pushed into mortgage products with 
associated risks and costs that they could not afford. Instead 
of utilizing affordable, low-cost financial services found at 
regulated banks and credit unions, too many working families 
have been exploited by high-cost, fringe financial service 
providers such as payday lenders and check cashers.
    Additionally, too many Americans lack the financial 
literacy, knowledge, and skills to make informed financial 
decisions, and I have two questions for you. What I am asking 
is what must be done. What must be done as we work toward 
reforming the regulatory structure for financial services to 
better protect and educate consumers?
    Mr. Bernanke. Well, I think this is absolutely critical 
because, as you point out, it was bad products that created a 
lot of the problem that consumers took, either knowingly or 
unknowingly. One direction which the Federal Reserve has taken 
is just to try to outlaw certain practices.
    We found, for example, in the context of credit cards, that 
people just do not understand double-cycle billing. I am not 
sure I fully understand it myself, to tell you the truth. And 
it is probably not worth the effort of trying to teach people 
what that means. It is probably better just to get rid of that 
practice because it is deceptive and people do not know how to 
understand it or work with it.
    There are other issues, though, relating to just the simple 
arithmetic of interest rates and so on that people really need 
to understand. It is not just a school issue. It is very much 
an issue for life. You know, people's hopes and dreams are tied 
into buying a house or sending a child to college and so on. 
And if they want to do that, they have to become reasonably 
acquainted with financial products and how to make choices and 
how to make good decisions. And it is good for the economy, 
too, because you get more competition, you get better products 
from that.
    So you and I, Senator, we have discussed this many times in 
the past. I think we strongly agree with each other that 
financial literacy is crucially important, and it is something 
that should get more attention than it already does in the 
schools.
    The Federal Reserve is very involved in this. We have done 
a lot of programs. We have worked with a lot of community 
organizations and others to try to create programs, to try to 
support efforts to spread financial literacy. I have to 
concede, though, that we have not got the magic bullet yet. It 
is difficult. People--kids, particularly--do not tend to be 
that involved or that interested in the topic until the actual 
time comes when they have to make some kind of financial 
decision. And so the most effective time is typically around 
the time at which the person is making their mortgage decision 
or their car-buying decision.
    So there is some case, I think, to do it in schools, but I 
think there is also a case to have better counseling so that 
people who are making financial decisions have access to some 
help and assistance so they can make better choices. But I 
absolutely agree with you that, just as in any other market, if 
you do not have informed consumers, you are not going to have 
an effective market. And that is very important.
    Senator Akaka. And what must be done to improve access to 
mainstream financial institutions in economically unserved 
communities?
    Mr. Bernanke. This is the issue of the unbanked, or the 
underbanked, again, an important issue. You have many people 
who, for whatever reason, haven't bothered or don't know how to 
open up a checking account and they end up paying money to cash 
their checks or to get a very short-term loan.
    We encourage banks and other financial institutions to do 
outreach, to try to provide services in underserved 
neighborhoods, to have multilingual tellers and so on, and I 
think that is not only good public policy, it is good business 
for them to reach out to broader groups in the population. So I 
think that is another important issue in which we bring people 
into the banking system.
    One way to do that, as I talked about in the past, in many 
cases, you have immigrants who want to make remittances back to 
their home country and some of the vehicles for making 
remittances are costly. Bringing them into the regular 
financial system, they can find cheaper, more effective, safer 
ways to send money home, and in doing so, they become 
acquainted with their local financial institution and become 
able to partake of the other services, like a checking account 
and a savings account.
    So that is very closely related to the financial literacy 
issue, about bringing people into the financial mainstream. 
Once again, that is one of the best things we can do for 
people, to allow them to make better use of their incomes and 
they get to have a better life.
    Senator Akaka. Thank you for your response.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator. That completes 
the round.
    I know my colleagues--I have a couple of questions for you, 
Mr. Chairman, as well. I think Senator Shelby, and I see 
Senator Corker here, as well, and I don't know if Senator 
Bennet may want to follow up, and I apologize to you, but you 
have seen the interest obviously in the membership showing up.
    I want to raise a couple of questions, one about bank 
holding companies, one about the potential of the Fed to buy 
Treasury bonds, and maybe one or two others.
    I mentioned in my opening comments some of the largest 
institutions that are experiencing significant problems were 
regulated by the Fed at the bank holding company level. Now, in 
addition to the bank holding companies that you historically 
regulated, we have many new companies that are applying for and 
been granted the bank holding company status by the Fed, 
including Goldman Sachs, Morgan Stanley, American Express, 
GMAC.
    Let me ask you a couple of questions. One is a basic 
question. I think I know the answer you want to give me, but I 
want to give you the chance to do so. As Chairman of the 
Federal Reserve, are you still committed to maintaining the 
separation between banking and commerce? And then second, given 
the problems that we have just seen with the more traditional 
bank holding companies, what assurances can you give the 
Committee that these new companies, the new applications that 
are coming through, which in many ways are different than the 
traditional bank holding companies, are going to be adequately 
regulated?
    Mr. Bernanke. Well, I do support the separation of banking 
and commerce, and in recent examples like GMAC, for example, we 
imposed very tough conditions about disentangling themselves 
from General Motors and from other commerce activities to 
become a finance company, essentially. So in that respect, we 
have been consistent.
    On bank holding companies, on the general principle, I 
think that consolidated supervision of large, complicated 
organizations is still very important, even more so important 
than we thought it was before because of the potential for a 
consumer finance company there or broker-dealer there to create 
a risk for the entire organization. So consolidated 
supervision, I think, is very important.
    We at the Fed are committed to doing that. I think, if 
anything, what we need to do is be even more aggressive at 
looking not only at the holding company level, but going down 
into the underlying companies beneath the holding company to 
make sure that they are observing consumer protections, safety 
and soundness, and the like. There was some tendency, I think, 
to defer entirely to the functional regulators who are 
responsible for the companies underneath the holding company. 
Indeed, we want to respect those priorities in the way that the 
Congress set up the rules, but the holding company supervisor, 
I think, does have a responsibility to make sure that not just 
at the holding company level, not just at the level of the 
policies that are being set by the top management, but down in 
the various organizations below that level that the policies 
are being followed and that companies are safe and sound.
    Chairman Dodd. Well, I welcome that and I would hope there 
is no additional authority that you need at the Fed in order to 
be able to exercise that authority.
    Mr. Bernanke. There has been some ambiguity. An example I 
would give would be consumer protection. What authority does 
the Fed have to look into a consumer finance company which is a 
subsidiary of a bank holding company when technically the 
primary regulator might be the FTC, for example.
    Chairman Dodd. Well, if it goes to the systemic safety and 
soundness and systemic risk of that institution, it would seem 
to me you have all the authority in the world.
    Mr. Bernanke. Well, before now, there were legal issues 
about what the appropriate priority was, who was primarily 
responsible, and so on, and what I am saying is that I think 
that what we have learned from this episode is that the holding 
company supervisor must have some ability, in conjunction with 
the functional regulator, to look at the condition and behavior 
of the firms below the holding company level, and that is 
something I have started doing and we intend to do.
    In terms of the new holding companies that have come in, we 
have been very assiduous in making sure they have adequate 
capital, that they have restricted themselves to the activities 
which are appropriate for holding companies, so they are not 
involving in all kinds of other commercial activities, and we 
believe we are able to deal with those companies. But more 
generally, we are revisiting and rethinking our whole holding 
company supervision approach to make sure that we have a really 
comprehensive enterprise-wide approach that looks at all the 
risk factors, not just at the holding company level but also 
throughout the organization.
    Chairman Dodd. Well, we need to stay closely in touch with 
you on that because that will be part of it.
    The second question I have has to do with, over the years, 
the Fed has not been active as a public trader in Treasury 
notes. In fact, it has been decades, I guess you could say, 
going back maybe to the very time that you are talking about 
historically, preferring instead to use the short-term Fed 
funds rate to manage interest rates. With the Fed's target 
interest rate basically at zero, you have been forced to 
consider other means of conducting monetary policy.
    In December, the FOMC said it was, and I quote, 
``evaluating the benefits of purchasing long-term Treasury 
securities.'' In January, FOMC said it is now prepared to do 
this if, quote, ``evolving circumstances indicate that such 
transactions would be particularly effective in improving 
conditions in private sector markets.'' Can you be more 
specific about those conditions that would lead the Federal 
Reserve to purchase long-term Treasury securities?
    Mr. Bernanke. Well, Senator, our objective is to improve 
the functioning of private credit markets so that people can 
borrow for all kinds of purposes. We are prepared, and we want 
to keep the option open to buy Treasury securities if we think 
that is the best way to improve the functioning or reduce 
interest rates in private markets. So we are certainly going to 
keep that option open.
    I should say, though, that we do obviously have a couple of 
other things going on right now. One is the purchases of the 
agency MBS and securities. The other is the proposed expansion 
of the TALF. So those are two directions that are certainly 
going to be taking up a lot of our attention in the short run. 
So we will keep that option open, but we are looking at some 
other ways of addressing the private markets, as well.
    Chairman Dodd. And just in that regard, raising the 
question, is it your view that an unacceptable rise in longer-
term Treasury rates slow economic growth, resulting in the Fed 
actually buying longer-term Treasury securities?
    Mr. Bernanke. Well, we want to look at the overall state of 
the economy, and I would just note that one possible scenario 
would be the Japanese, where there was a more general 
quantitative easing approach, and the focus was not on specific 
credit markets but broadening the monetary base in general. In 
that case, the Japanese have and currently are buying long-term 
government bonds. That would be one possible scenario.
    But again, the basic goal here is to improve the 
functioning of private credit markets. We are not trying to 
affect the cost of government finance, per se, rather the 
private sector.
    Chairman Dodd. I have gone over a little bit. Let me turn 
to Senator Shelby and then Senator Corker.
    Senator Shelby. Mr. Chairman, Secretary Geithner stated 
that the Treasury will direct bank regulators, including the 
Federal Reserve, to begin a form of stress testing. Now, I 
believe it was a writer with the New York Times, Gretchen 
Morgenson, she wrote a week or so ago something that said, you 
know, before you can do a stress test on somebody, you have got 
to find the pulse, indicating that some of these banks were 
walking dead. I believe that was a term that Senator Corker 
used one time.
    If you are propping them up, how long can you prop them up 
and should you prop them up, because a lot of us don't believe 
anything is too big to fail. Obviously, you think some 
institutions are too big to fail. But your predecessor, one of 
your predecessors, Dr. Volcker, who is a well respected 
economist, he testified before this same Committee several 
weeks ago that he thought some institutions, some banks were 
too big to exist, you know, too big.
    Now, having said that, I think you can fool the market a 
little bit every now and then, but not for long. The market 
basically has looked at a lot of these banks and they know they 
are in deep trouble. They know that some of them, or at least 
the market thinks some of them are basically gone, or should be 
gone. So this begs the question of nationalization. You know, 
this has been brought up.
    I think you can take over a bank by converting the 
preferred, as you are talking about CitiCorp or some of them 
are talking about doing, and if you had 40 percent working 
control of CitiCorp, you basically would--you wouldn't own it 
all, but you would own working control, probably, and you would 
be the big power in the boardroom, so to speak. Or you could 
take over a bank by taking it over, do away with stockholders 
and it becomes totally owned by the government, so to speak. 
Neither one of those options, to me, is very desirable.
    I guess, where are you going? Can you say that today? Where 
are we going?
    Mr. Bernanke. Well, what we are doing is trying to assess 
how much capital these banks need in order to fulfill their 
function even in the stress scenario. So we are going to do an 
honest evaluation. We are going to do a tough evaluation, try 
to figure out how much hole there is, if there is a hole. In 
many cases, there is not a hole.
    Senator Shelby. Do you believe that most of those banks can 
withstand the stress test, a real stress test?
    Mr. Bernanke. The outcome of the stress test is not going 
to be fail or pass. The outcome of the stress test is, how much 
capital does this bank need in order to meet the needs of the 
credit--the credit needs of borrowers in our economy.
    You mentioned having majority ownership and so on. We don't 
need majority ownership to work with the banks. We have very 
strong supervisory oversight. We can work with them now to get 
them to do whatever is necessary to restructure, take whatever 
steps are needed to become profitable again, to get rid of bad 
assets. We don't have to take them over to do that. We have 
always worked with banks to make sure that they are healthy and 
stable, and we are going to work with them. I don't see any 
reason to destroy the franchise value or to create the huge 
legal uncertainties of trying to formally nationalize a bank 
when it just isn't necessary.
    I think what we can do is make sure they have enough 
capital to fulfill their function and at the same time exert 
adequate control to make sure that they are doing what is 
necessary to become healthy and viable in the longer term.
    With respect to your question about too big to exist, as I 
have said before, there is a too big to fail problem which is 
very severe. We need to think hard going forward how we are 
going to address that problem, but right now, we are in the 
middle of the crisis.
    Senator Shelby. Have you thought about ways to deal with 
it? We understand that some banks pose, or some institutions 
like AIG, systemic risk to the whole financial system----
    Mr. Bernanke. Well, we are working right now on some 
proposals on resolution. One of the big problems is that if we 
wanted to close down a major institution, we don't have the 
legal authorities and the framework to do it. So the Congress 
needs, in my opinion, to set forward a much more elaborate 
version of FDICIA, if you like, that would apply to large 
financial institutions of various types that would give 
guidance to regulators, under appropriate checks and balances, 
about under what circumstances the regulators could shut down 
that firm in a safe way that doesn't disrupt the financial 
markets. But absent those kinds of powers and that kind of 
framework, we really are having to play it by ear.
    Senator Shelby. I know a lot of people have got different 
proposals for the economy and how do you rectify the economy. I 
was told the other day there are about 155 million people 
gainfully employed. We would like for it to be six or seven or 
eight million more. I understand that. But do you believe that 
the biggest challenge to our economic system today is 
rectifying and bringing competence and capital from the private 
sector, trust to the banking system?
    Mr. Bernanke. Absolutely, Senator. Somebody asked me 
before, how would we know when things were starting to turn 
around? When some major banks start going out and raising 
significant private capital----
    Senator Shelby. In the private sector?
    Mr. Bernanke. In the private sector, that will be a major 
indicator that we are moving in the right direction.
    Senator Shelby. And how do you do that with transparency, 
with closing some banks, consolidating some banks, letting the 
market know or believe in the banking system?
    Mr. Bernanke. Well, the various steps that I have 
described, including making sure they have enough capital to 
give themselves some breathing space to do restructuring as 
needed, to have a program to buy assets off the balance sheets. 
Some of those steps that I have talked about will, if properly 
executed and forcefully executed, lead to a situation where it 
will be safe to come back in the water and private investors 
will be more confident about the futures of the banks.
    Senator Shelby. You are the Chairman of the Federal 
Reserve, which is the central bank, but you are also the 
regulator of our largest banks, is that correct?
    Mr. Bernanke. Of the holding companies, yes.
    Senator Shelby. Do you believe, and I know you haven't been 
in the Fed that long, but do you believe that the Fed has 
adequately supervised our banks as a regulator, or do you 
believe there were problems there that were not known or 
uncovered?
    Mr. Bernanke. Well, I think the Fed was a very active and 
conscientious regulator. It did identify a lot of the problems. 
Along with our other fellow regulators, we identified issues 
with non-traditional mortgages, with commercial real estate, 
with leveraged lending and other things. But what nobody did 
was understand how big and powerful this credit boom and the 
ensuing credit collapse was going to be, and routine 
supervision was just insufficient to deal with the size of this 
crisis. So clearly, going forward, we need to think much more 
broadly, more macroprudentially, about the whole system and 
think about what we need to do to make sure that the system as 
a whole doesn't get subjected to this kind of broad-based 
crisis in the future.
    Senator Shelby. Does that include insurance, too, because 
insurance has been regulated under the McCarran-Ferguson Act by 
the States, but then you had AIG, which caused systemic stress, 
to say the least, to our banking system, and they were 
regulated primarily by the New York State Insurance Commission.
    Mr. Bernanke. AIG had a Financial Products Division which 
was very lightly regulated and was the source of a great deal 
of systemic trouble. So I think that we do need to have 
broader-based coverage, more even coverage, more even playing 
field, to make sure that there aren't--as our system evolves, 
that there aren't markets and products and approaches that get 
out of the line of vision of the regulators, and that was a 
problem we had in the last few years.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Dodd. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman, and thank you for 
the second round of questioning.
    How many major banks, I mean, is the definition 19 or 20, 
is that what we determine to be major banks in this country?
    Mr. Bernanke. There are about 20 banks or so that are $100 
billion in assets or bigger.
    Senator Corker. OK.
    Mr. Bernanke. Those are basically the ones that we are 
going to be looking at in the next few----
    Senator Corker. So I want to spend just a minute on the 
stress test and then move to a bigger issue. You mentioned that 
on the accrual loans, we were going to use existing accounting, 
which is GAAP accounting. My understanding is the banks 
actually take losses on those loans as they occur.
    Mr. Bernanke. Well, there is some provisioning for future 
losses and we will be looking at a 2-year horizon and asking 
the question, what are the expected losses over that whole 
horizon.
    Senator Corker. So what you really will be doing, then, is 
going in and ensuring that they are actually provisioning 
properly, and the fact is that I think most--a lot of smart 
people in the country believe that that is where the huge 
losses exist that have not been taken, obviously because of 
GAAP accounting, and what you are going to do is actually get 
them to increase those reserves substantially. At that point, 
they will be insolvent, and so, therefore, then you would be 
providing public funding to make up that capital deficiency, is 
that correct?
    Mr. Bernanke. I don't agree necessarily that they will be 
insolvent, but clearly----
    Senator Corker. Well, some of them obviously will.
    Mr. Bernanke. Clearly, we have to look at their 
provisioning. The rules are that you can account for those 
expected losses either through provision or through more 
capital, but essentially it is the same point.
    Senator Corker. And the reason for additional--their 
capital will be too low, so they might not be insolvent, but 
the fact is they would need in some cases substantial public 
investment to get their capital ratios where they need to be so 
they would be considered solvent, let me put it that way.
    Mr. Bernanke. So they would be considered well capitalized.
    Senator Corker. OK. So I guess as I hear that, there seems 
to be sort of two schools of thought. One is that we need to 
take our medicine and that there needs to be some failures or 
maybe we need to have a bad bank scenario under these major 
banks, because in some cases, they could actually support their 
own bad bank. And then there is another that says we are just 
sort of going to meter out losses over time and continue sort 
of what we have been doing, and I am not criticizing, I am just 
making the observation that I think what I heard you say is, in 
essence, we are sort of going to continue doing what we are 
doing. We are going to go in and create this mechanism, these 
convertible preferred shares, and as the banks actually take 
these losses which we know are coming, they will convert that 
into common equity. But in essence, we are sort of continuing 
what we have been doing with TARP funding. We are just calling 
it something a little different to get the tangible common 
equity up where it needs to be, is that correct?
    Mr. Bernanke. And to make the banks well capitalized so 
there will be some public ownership in terms of the shares of 
the common equity, but we want them to have enough capital.
    Senator Corker. Mr. Chairman, just for what it is worth, I 
think that is incredibly enlightening, probably the most 
enlightening thing that has been said in the last 5 weeks as 
far as where we are going, which again I don't criticize. I 
think we need to get it right.
    But it seems to me that this has been creating this sort of 
dead man walking, this sort of zombie-like banking scenario, 
and while I have been not using these words out and around, it 
seems to me that what you have explained is a creeping 
nationalism of our banks. I mean, in essence, many of them 
don't have appropriate capital. You are going to stress test 
them, which means you are going to make them reserve up 
properly, which they should do and I applaud that. And then you 
are going to provide the public funding to meet that capital 
requirement. I don't like saying things like this and squirmed 
a little bit when I was asked about Chairman Dodd's comments 
about nationalization, but in essence, this is a form of sort 
of creeping nationalism, right?
    Mr. Bernanke. Senator, there are two sides to this. One 
side is providing the capital they need to provide credit to 
the economy, which is essential. But we are not just handing 
them this capital and saying, go do your thing. We also have on 
the other side the supervisory oversight, the TARP oversight, 
to make sure that they are not just sitting around but that 
they are taking the steps necessary to clean themselves up so 
that they will be profitable in the future. At that point, 
private capital will come in and public capital can go out. And 
as I was saying before, the best sign of success will be when 
the government can start taking its capital out, or the banks 
can start replacing the public capital with private sector 
capital. That is what we are aiming for.
    Senator Corker. I just took your comment earlier, you know, 
there are a lot of assumptions about what our public policy is 
and I think people understand about the condition that Senator 
Shelby mentioned about too big to fail. But when you stated 
earlier, we are committed to ensuring the viability of all 
major U.S. financial institutions, that is a statement that I 
guess I have never heard said that clearly before and I think 
that some of us have expected that there is at least a 
possibility if a financial institution is not performing 
properly they might be seized, which is certainly a form of 
nationalization, for a period of time, but it is different. It 
is under different circumstances.
    But what I hear you saying today--again, I am not being 
critical, I might be later, but I am just observing right now--
is that we are going to get them to sort of take their 
medicine. We are going to go in and make them reserve up for 
these accrual loans that we know is where the next huge hole 
is, but we are going to give them public dollars. I mean, that, 
to me, and I certainly haven't been around that long here, but 
that, to me, is nationalization. I mean, that--I would like for 
you to give me a term to use as I leave here as to what we 
would call that.
    Mr. Bernanke. Call it public-private partnership. It is not 
nationalization because the banks will not be wholly owned or 
probably not even majority owned by the government. The 
government will be a shareholder, along with private 
shareholders----
    Senator Corker. But you are putting in a mechanism to where 
our common equity holdings will be large by virtue of creating 
this convertible preferred situation and you know that the 
losses are coming because you are going to do this stress test. 
I mean, that is why you are putting this vehicle in place. And 
I do wonder how we ever get to the end game where in essence 
there are, in fact, people willing to buy common shares. I 
mean, I can't imagine in these 19 or 20 institutions anybody, 
after hearing this statement today, which maybe you have said 
it before and I hadn't heard it, but why would anybody go buy 
common shares in banks today in those 19 or 20? Why would 
anybody do it?
    Mr. Bernanke. Well, they wouldn't today, but I think 
eventually they will. It is all the elements of the program 
working together to take off the bad assets, to recapitalize 
them, to get them restructured. I think part of this is that, 
remember, we do have a legal procedure. We do have the FDICIA 
laws and prompt corrective action. If a bank does become 
insolvent, then the FDIC will, of course, intervene. But we are 
not close to that. All the banks are above their regulatory----
    Senator Corker. Well, they are only there because we are 
continuing--I mean, the statement has been made that we are 
going to keep putting public dollars in to keep that occurring, 
so they are never going to get to a point, these 19 or 20 banks 
will never get to a point where the seizure occurs because you 
are putting in place a mechanism to keep that from happening, 
and I am just saying that is a really bold statement and 
something that I guess I haven't deciphered until today. Have 
you heard this, Mr. Chairman?
    Chairman Dodd. Well, I just say, look, I mean, we are in--
as the Senator from Connecticut learned a few days ago, a full 
statement saying that I thought this was a bad choice to go to. 
The administration, in my view, is opposed to it. But when 
pressed, could something like this happen, I should have been 
more careful in my selection of words. We need to be careful 
here in the language we are using at this very hearing.
    And as I hear my colleague, he is raising some very good 
questions. But I think I heard the Chairman also describing 
this is not a desirable result we are looking at here. The 
desirable result is these institutions to be run and managed in 
private hands. That is the goal we are trying to achieve here. 
I think we need to be careful to make sure we are not going to 
contribute to the very outcome we are trying to avoid.
    Senator Corker. But I think the mechanism that is being put 
in place is a mechanism that absolutely means that none of the 
20 major--19, 20 major banks in our country ever have the 
chance of being seized, and, in essence, that we are going to 
put whatever public capital in place once they do the 
appropriate amount of reserving that needs to take place, and I 
applaud you for doing that, to make sure that that doesn't 
occur, that they have proper capital ratios. That is what I am 
hearing----
    Mr. Bernanke. Senator, it is not a statement of principle 
or forever. Based on our knowledge of those banks and where 
they are and where we think they are going to come out, we 
believe this is the best way forward.
    Senator Corker. Isn't that tantamount to saying that for a 
period of time while all of this is occurring, in essence, 
the--and again, it is not a criticism, it is an observation--
there is no need for private investment in these institutions, 
that we are going to go through a period of time where, in 
essence, the public sector, as it has been, but we are making 
now this sort of a statement now that for a period of time, the 
only viable avenue for these institutions is going to be the 
public sector, and we are just acknowledging that that is the 
case.
    Mr. Bernanke. It has been the case. If we hadn't had the 
TARP money in October, we would have had a global banking 
crisis. Many, many banks would have failed and the results 
would have been extremely bad.
    Senator Corker. And it seems to me that what we are 
throwing out is that notion that some folks have put forth--
again, I am just observing--of creating some mechanism for 
these banks to actually be healthy now that is not going to 
happen, that in essence this good bank/bad bank scenario where 
someone actually proposed for the four largest banks they just 
create their own, where in essence the assets are separated 
from these institutions and people might actually invest in 
them. That idea is definitely not one of pursuit today.
    Mr. Bernanke. Senator, let me be clear. If there is a 
private sector solution, including private capital raised, that 
is great----
    Senator Corker. No, no, no, no.
    Mr. Bernanke. That is great.
    Senator Corker. This will be a public--I mean, the public 
sector would have to be involved, it seems, in helping create a 
good bank/bad bank, where they are separated. But the point is 
you are making a statement today that things of that nature, 
where we are actually going to try to separate these bad assets 
in that mechanism and actually calls people to invest in the 
good side of the bank, that thought process is not the pursuit 
of today.
    Mr. Bernanke. Senator, I don't want to speak for the 
Treasury about what might happen in terms of individual cases, 
but there is one issue with that bad bank that you are 
describing, which is that it is very difficult to value the 
assets that you put into the bad bank. One of the advantages of 
the private-public partnership asset purchase program is that 
we would hope to get market-based prices so the taxpayer 
wouldn't be overpaying for the assets which are, one way or 
another, made the responsibility of the government.
    Senator Corker. And I will stop. I know you have been very 
generous with the time, Mr. Chairman----
    Chairman Dodd. Let me ask this, if I can----
    Senator Corker. Let me just follow up with this last--I am 
stopping with this. It seems to me that all of us have talked 
about the need for the credit markets to function, and you have 
stated that on the front end and all the way through, and I 
know Chairman Dodd and Ranking Member Shelby have said the same 
thing. I see no event, based on what you just said, I see no 
event that changes the mix in any way to really cause that to 
occur. I mean, what I see is this sort of continuation of this 
sort of dead man walking, zombie bank, whatever you want, just 
sort of this going on for a period of time and there is 
nothing, no jolt of any kind that offers any kind of different 
scenario with our major institutions as I listen to what you 
are saying.
    Mr. Bernanke. I must not be very clear. I apologize. First 
of all, I think ``zombie'' was not an appropriate description 
for any of the banks. I think they all have substantial 
franchise value. They are all lending. They are all active. 
They have substantial international franchises. So I don't 
think that is an accurate description.
    But the point I want to make is that even as we put capital 
into these banks, we are not standing by and letting them do 
what they want, to take risks or to continue to operate in an 
inefficient manner. We are going to be very tough on them to 
make sure, along with the private shareholders who still have 
an interest, that they take whatever drastic steps are 
necessary to restore themselves to profitability, and that is 
what is going to make them eventually interesting to private 
investors.
    Chairman Dodd. You know, I just want to--in picking up on 
the point, first of all--and this is, I think, a very important 
exchange because it is a critical question. The announcement of 
the stress itself has, I think, created stress in a sense in 
terms of how the private sector looks at the institutions, in 
terms of their willingness to provide the additional private 
capital, which is critical--ultimately what we are seeking 
here. So you might address that question.
    And the public-private partnership idea is one that I think 
has some value, because if we are only talking about people 
coming and investing in entities that have Government 
guarantees to them one way or the other, whether it is 
treasuries or commercial paper, whatever the laundry list is of 
investments you can make and you are making them because there 
is a Government guarantee. Then it seems to me we are missing 
what ultimately needs to be done, and that is, getting capital 
to invest in those riskier investments that do not have the 
guarantees. Ultimately, that is the answer. And so the question 
is: How do we get closer to that model that attracts that 
private investment in the non-Government guaranteed instruments 
that are out there?
    There are some ideas kicking around about creating a fund 
in a sense in the public-private partnership idea that would 
take qualified investors from hedge funds and money markets and 
others to begin to use their capital and public capital as a 
way of creating markets--a buyer and a seller. I mean, what we 
are missing here is the buyer and the seller. That is what 
creates a market. You do not create a market by Government 
action or Government regulation. You create a market when you 
have a buyer and a seller showing up and they decide to engage 
in a negotiation over the purchase of an instrument. And until 
that moment begins to happen, obviously we are buying the time 
to get to that point and trying to urge this along.
    My colleague from Tennessee, who I have great admiration 
for and have immensely enjoyed my working relationship with, 
raises a very, very important question. I think we agree on 
where we are trying to get to, and I think you very cautiously 
raise the issues of which path are we sort of following here. 
What I hear you saying is, one, to try and make sure we have 
institutions around where we can actually perform, and 
simultaneously then create the opportunities through these 
public-private partnerships that have been suggested by some as 
a way of inducing that private capital to come in and that 
buyer and that seller to show up. And when the buyer and the 
seller show up, they start creating the markets, and these 
assets, then we can determine their value, these toxic assets, 
and credit begins to flow. And that to me is the heart of it 
all on how we get there.
    Anyone who suggests that one path or the other guarantees 
us an outcome, but in the absence of providing the 
institutional framework by which you then can move seems to be 
a dangerous one if we do not be careful.
    So I do not know if you want to comment on that at all or 
not, but I would give you a chance to respond to that.
    Mr. Bernanke. No, I think that is well put. I think we want 
to get as much certainty about the policy going forward so 
people understand the rules. There have been complaints about 
that, and it is well justified. We want to do what we can to 
both get the banks back on a profitable path, to get the bad 
assets off their books, and to make them attractive again. And 
I think you are absolutely right that that is the end game, 
when private money will start coming back in. And I am sure it 
will happen. The sooner, the better.
    Chairman Dodd. Let me ask you just one question I wanted to 
raise. And I appreciate, by the way, your point on the TARP, 
and I thank my colleague from Tennessee. He was critically 
helpful in that critical moment, those 14 days of trying to put 
something together that made some sense, and your point that 
had we not acted, we would be having a very different 
conversation in this room today, I think is what you are 
telling us. And we would be talking about not whether or not 
these institutions are going to be around. They would be gone, 
many of them. Is that correct?
    Mr. Bernanke. Yes.
    Chairman Dodd. Yes. The role of the Community Reinvestment 
Act, this item keeps on popping back up again. We had some 
lengthy debates in this Committee, as I was a junior Member of 
it when we went through with it. My good friend Phil Gramm of 
Texas was the Chair, and Phil and I did a lot of work together 
on a number of issues. But Phil the other day wrote another 
piece about the CRA is a fundamental issue, and yet I see in a 
February 12 study by the boss in the San Francisco Fed cited 
evidence showing that 60 percent of the higher-priced loans in 
that period of time we are talking about went to middle- and 
higher-income borrowers or neighborhoods not covered by the 
Community Reinvestment Act, that loans originated by the CRA-
covered lenders were significantly less likely to be in 
foreclosure than those originated by lenders not covered by the 
CRA.
    An October 14 study from the University of North Carolina 
and the Center for Community Capital showed that home loan 
borrowers with similar risk characteristics defaulted at much 
higher rates when they borrowed subprime mortgages than when 
they received community reinvestment loans.
    Do you agree with that?
    Mr. Bernanke. Yes, that is what the Fed research shows. I 
think the number is that only 6 percent of the subprime 
delinquencies were based on mortgages made by CRA-covered 
institutions into CRA neighborhoods.
    Chairman Dodd. Yes.
    Mr. Bernanke. So, we know that mortgage brokers and others 
were very much involved in making those loans, and they are not 
covered by CRA.
    Chairman Dodd. But the underwriting standards in 
institutions dealing with community reinvestment are very 
tough. Do you agree with that? Well, not tough----
    Mr. Bernanke. I would not want to make a complete blanket 
statement, but certainly the banks which are more directly 
regulated, and Federal regulators, did a better job on average 
of underwriting mortgages than did the non-federally regulated 
lenders.
    Chairman Dodd. My colleague Senator Shelby has some 
comments.
    Senator Shelby. Mr. Chairman, a lot of people believe--and 
you have seen a lot of the writings--that the Fed and Treasury 
and others basically have exacerbated, compounded the problem 
for the banks by propping them up. In other words, I am going 
to back to the market. The market obviously believes that some 
of those banks--not all--maybe are insolvent, you know, have 
been insolvent basically by standard accounting stuff.
    Wouldn't we be better off to close some of those banks 
rather than continue to prop them up and let the American 
people continue to believe--no confidence in them? In other 
words, they are not buying stock. They are not investing in the 
private banks because they do not trust them, you know, because 
they do not know what is in those portfolios. And when the 
Government, which is the Fed and others, get involved in that--
I know you are the lender of last resort, and you are also a 
bank regulator. I understand all that. But aren't you sending a 
message out, like Senator Corker--that we are going to keep 
these banks open no matter what? How are you ever going to 
track private capital? And there is a lot of private capital, 
as you know, Mr. Chairman, on the sidelines now looking for an 
investment. But they are not investing in the banks because 
they do not trust the banks.
    Mr. Bernanke. The first step, Senator Shelby, I think is to 
get the clarity. Get the clarity.
    Senator Shelby. Transparency?
    Mr. Bernanke. Transparency. And there are two parts of this 
program that are going to do that. The first is the assessment 
that we are undertaking, and the second is what happens after 
the asset purchase program goes into place and takes assets off 
their balance sheets.
    But, you know, Senator, we are following the law. The law 
has a very explicit set of rules under which we can go in and 
shut down a bank.
    Senator Shelby. We know that.
    Mr. Bernanke. We cannot just go shut down a bank that is 
well capitalized or meets capital standards.
    Senator Shelby. You should not ever do that. But we are 
talking about the banks that are insolvent or have no pulse, so 
to speak.
    Mr. Bernanke. I think there are a couple of issues, 
practical issues, that people need to pay attention to. One is 
just the great technical difficulty of shutting down an 
enormous holding company with many components, an international 
presence.
    Senator Shelby. We understand that.
    Mr. Bernanke. And the implications that would have for 
market function and market confidence. I think that would be 
enormous. And we saw some of that with Lehman Brothers, 
frankly.
    The other is I think----
    Senator Shelby. We have seen some of that with AIG, haven't 
we?
    Mr. Bernanke. And with AIG. If I thought the banks were, 
you know, irrevocably damaged, I would have a different view. 
But I do believe that our major banks have significant 
franchise values. And one of the things that we have learned is 
that when the Government takes over a company, one of the 
things that happens immediately is that the counterparties 
start pulling away the franchise value, the brand name starts 
to erode very quickly.
    And so I think, if through our regulatory process we can 
get the banks to perform better and to improve, then the time 
may come when, if they do not succeed in doing that, it will be 
appropriate to shut them down and so on. But for the moment, I 
think the right strategy is transparency, find out what we can 
about their true status, and to try to find the minimally 
disruptive way to get them into an improved condition. And I 
think those things are feasible right now.
    Now, we certainly, as I said to Senator Corker, there is no 
commitment by any means to never shut down a big bank. 
Absolutely not. But I do believe that the major banks we have 
now can be stabilized, and in the near term, it is important to 
do so.
    Senator Shelby. Are we going down the road that Japan went 
down in a sense? Some people say we are. Some say we are not. 
In other words, they never confronted their banking problems in 
the 1990s. Have they----
    Mr. Bernanke. We have been very----
    Senator Shelby. Sir?
    Mr. Bernanke. I am sorry.
    Senator Shelby. Are we going down the same road in a sense?
    Mr. Bernanke. No, Senator. We----
    Senator Shelby. Propping up banks that are dead, so to 
speak?
    Mr. Bernanke. No, Senator. As I said, we are going to 
transparency. We want to find out what their true positions 
really are, and if we, the regulators, the Treasury, were to 
determine that a bank were really not viable, that would be a 
different question. But right now the view is that these 
assessments will determine how much capital they need to 
continue to lend and support the economy.
    Senator Shelby. Last, how do you get the market to believe 
that what you are doing is the right thing? Obviously, most of 
them do not. Most of the participants in the market that are 
keen observers do not believe in what you are doing with the 
banks, because look at the bank stocks.
    Mr. Bernanke. Well, there are a lot of factors affecting 
bank stocks, including uncertainty about what the Government 
might do.
    Senator Shelby. Sure.
    Mr. Bernanke. So I am not sure you can make that judgment. 
I think we have to go forward. We have to try to ascertain the 
state of the banks. We have to see what the situation really 
is. But my belief is that what we will come out with is capital 
that will allow these banks to continue and to provide the 
credit that we need and do so in a way that is not as 
disruptive to the markets as would be the alternative at this 
point.
    Senator Shelby. Thank you.
    Chairman Dodd. The last point I would make I think is very 
important. I think obviously the markets are skittish, and 
obviously there is a lot going on. And clarity is very 
important, the transparency you are talking about. I think the 
more people--Bob mentioned this earlier, and I wish I had said 
it myself at the outset. So much of what is missing is getting 
that sense of the framework, where are we. I think people 
understand how we got here. We can talk about that. But where 
are we? What needs to be done to get us moving in the right 
direction? And I think to the extent people understand that--
they may not like it, but they understand it--then you do not 
get these kind of high volatility and jerking around that we 
see so often where one statement from one individual can have a 
significant impact on a market fluctuation. I think that is in 
a sense what happens when there is this lack of certainty or 
clarity, to the extent you can have certainty, obviously, in an 
environment like this.
    I think these closing comments, while they have not 
involved a lot of people here, I think they have been 
tremendously valuable and important, and your responses to 
Senator Shelby I think have been very helpful as well on all of 
that. And I do think sometimes we--the markets are very 
important, obviously. We watch them every day. But I think too 
many times we look at only that every day as an indication of 
where things are going. And it is an important indication, but 
it is not the only indication of what is happening. And I think 
that is the point you were trying to make, and I welcome that.
    We thank you very, very much----
    Senator Corker. Mr. Chairman, could I--this is not getting 
into an ideology discussion. The statement was made earlier 
that the Federal Reserve does not have the authority to close 
down a large institution. I think the Chairman may have been 
referring to AIG. I am not sure. But I am wondering if it would 
be good for him to clarify, and then since this Committee, I 
guess, would have something to do with that, if there is 
something that he is asking for, because what I would hate to 
happen is 2 years from now we end up in a situation, if it is 
AIG--he might have been talking about Citigroup. I do not know 
who he is talking about. I would love the clarification. But I 
would hate for us to wake up 2 years from now and the Fed be 
saying, well, we would have done it, but we did not have the 
authority to do it. And I am just wondering if he might clarify 
since that is an important----
    Mr. Bernanke. Senator, thank you. I have talked about this 
on a number of occasions. I think what is missing is a 
comprehensive resolution authority, a set of rules and 
guidelines which explains how the Government in general would 
address the potential failure of a systemically critical firm, 
like AIG, for instance.
    Senator Corker. So it could be Citigroup. It could be any 
firm.
    Mr. Bernanke. Right. The existing rules do not cover a 
Citigroup because that is a bank holding company with lots of 
different components. So we do not have a good framework for 
dealing with systemically critical firms. At the Fed we are 
working on some proposals. We would be happy to share them with 
you at some point. But I do think that that is the first step. 
Until it is safe to close down a big firm, you are going to be 
forced to take actions to avoid it. And as I said, I would be 
very happy to get rid of the 5 percent of my balance sheet 
which is tied up in these kinds of extraordinary rescue 
efforts.
    So it is critical that we have a good resolution regime, 
and we are working hard on it and would be happy to share with 
you, Senator Corker----
    Senator Corker. So you are not asking--you are not going to 
come back in a year and say, well, we would have closed down X 
or AIG, but we do not have that authority, we are working 
toward that end?
    Mr. Bernanke. I am hoping this will be part of the broad 
reform package that is going forward.
    Chairman Dodd. And I think you made that clear in the past. 
The Lehman Brothers issue, I know there has been a highly 
controversial question, obviously. But there was a classic, 
where allowing that to default was certainly--that was within 
the authority.
    Mr. Bernanke. Well, we had no way to address it otherwise.
    Chairman Dodd. Yes. So there is, I think--it is a good 
question, but I think it has been answered by actions already 
that have occurred, as well as the statements you have made 
today.
    Well, Mr. Chairman, it has been a long 4 hours, and I know 
you have got Budget Committee hearings later this week, so we 
hope this has been helpful in preparation for those hearings.
    I would like as well at some point--stabilizing the 
financial system is obviously the critical question, and I 
think the Committee might be interested in the Fed's 
suggestions in terms of prioritizing the kinds of steps that we 
should be taking in this Committee. I would be very interested 
in your observations and those of your staff as to what sort of 
batting order you would like to see this Committee of 
jurisdiction over the financial institutions of the country to 
bring up and what are the most important issues we ought to 
address more quickly, and some will require probably some 
longer thought. And I privately have chatted with the Chairman 
about tapping into the expertise of the Federal Reserve System 
to talk about the modernization issues that many--or I think 
every Member of this Committee has an interest in, and how we 
proceed along those lines.
    So we would like to call on the Federal Reserve's fine 
staff to get some sense of what you think we ought to be doing 
in what order as to how we ought to proceed. It would be 
helpful.
    This has been very helpful, a good hearing. Thank you for 
being here.
    [Whereupon, at 1:20 p.m., the hearing was adjourned.]
    [Prepared statements, response to written questions, and 
additional material supplied for the record follow:]
               PREPARED STATEMENT OF SENATOR TIM JOHNSON
    Thank you, Chairman Bernanke for being here today. It is no 
exaggeration to say that our economy is currently undergoing a period 
of extraordinary stress and volatility. Unfortunately, I suspect we are 
not yet at the end of the road in terms the financial difficulties 
plaguing Americans.
    I applaud the Federal Reserve for continuing to use its tools to 
lessen the impact of the recession, to decrease the volatility in the 
markets, and to unfreeze credit markets, but I have concerns that as 
the Federal Reserve expands its balance sheets and interest rates 
remain near zero, that the Fed will have fewer options and less 
flexibility than it has had over the past year. I am also concerned 
that some of these actions may perpetuate the idea that the government 
is in the business of propping up insolvent ventures when they go bad.
    I am deeply interested in the Fed's economic forecast for 2009, and 
I look forward to hearing how the Fed will continue to address the 
problems plaguing our economy.
    The crisis in our economy is real, and there is no question that 
more must be done to address the situation. I am committed to our 
Nation's economic recovery and to ensuring the safety and soundness of 
the financial sector without placing unnecessary burdens on the 
taxpayer. As this Committee works to address the crisis in our economy, 
we will continue to look to your expertise.
                                 ______
                                 
                 PREPARED STATEMENT OF BEN S. BERNANKE
       Chairman, Board of Governors of the Federal Reserve System
                           February 24, 2009
    Chairman Dodd, Senator Shelby, and members of the Committee, I 
appreciate the opportunity to discuss monetary policy and the economic 
situation and to present the Federal Reserve's Monetary Policy Report 
to the Congress.
Recent Economic and Financial Developments and the Policy Responses
    As you are aware, the U.S. economy is undergoing a severe 
contraction. Employment has fallen steeply since last autumn, and the 
unemployment rate has moved up to 7.6 percent. The deteriorating job 
market, considerable losses of equity and housing wealth, and tight 
lending conditions have weighed down consumer sentiment and spending. 
In addition, businesses have cut back capital outlays in response to 
the softening outlook for sales as well as the difficulty of obtaining 
credit. In contrast to the first half of last year, when robust foreign 
demand for U.S. goods and services provided some offset to weakness in 
domestic spending, exports slumped in the second half as our major 
trading partners fell into recession and some measures of global growth 
turned negative for the first time in more than 25 years. In all, U.S. 
real gross domestic product (GDP) declined slightly in the third 
quarter of 2008, and that decline steepened considerably in the fourth 
quarter. The sharp contraction in economic activity appears to have 
continued into the first quarter of 2009.
    The substantial declines in the prices of energy and other 
commodities last year and the growing margin of economic slack have 
contributed to a substantial lessening of inflation pressures. Indeed, 
overall consumer price inflation measured on a 12-month basis was close 
to zero last month. Core inflation, which excludes the direct effects 
of food and energy prices, also has declined significantly.
    The principal cause of the economic slowdown was the collapse of 
the global credit boom and the ensuing financial crisis, which has 
affected asset values, credit conditions, and consumer and business 
confidence around the world. The immediate trigger of the crisis was 
the end of housing booms in the United States and other countries and 
the associated problems in mortgage markets, notably the collapse of 
the U.S. subprime mortgage market. Conditions in housing and mortgage 
markets have proved a serious drag on the broader economy both 
directly, through their impact on residential construction and related 
industries and on household wealth, and indirectly, through the effects 
of rising mortgage delinquencies on the health of financial 
institutions. Recent data show that residential construction and sales 
continue to be very weak, house prices continue to fall, and 
foreclosure starts remain at very high levels.
    The financial crisis intensified significantly in September and 
October. In September, the Treasury and the Federal Housing Finance 
Agency placed the government-sponsored enterprises, Fannie Mae and 
Freddie Mac, into conservatorship, and Lehman Brothers Holdings filed 
for bankruptcy. In the following weeks, several other large financial 
institutions failed, came to the brink of failure, or were acquired by 
competitors under distressed circumstances. Losses at a prominent money 
market mutual fund prompted investors, who had traditionally considered 
money market mutual funds to be virtually risk-free, to withdraw large 
amounts from such funds. The resulting outflows threatened the 
stability of short-term funding markets, particularly the commercial 
paper market, upon which corporations rely heavily for their short-term 
borrowing needs. Concerns about potential losses also undermined 
confidence in wholesale bank funding markets, leading to further 
increases in bank borrowing costs and a tightening of credit 
availability from banks.
    Recognizing the critical importance of the provision of credit to 
businesses and households from financial institutions, the Congress 
passed the Emergency Economic Stabilization Act last fall. Under the 
authority granted by this act, the Treasury purchased preferred shares 
in a broad range of depository institutions to shore up their capital 
bases. During this period, the Federal Deposit Insurance Corporation 
(FDIC) introduced its Temporary Liquidity Guarantee Program, which 
expanded its guarantees of bank liabilities to include selected senior 
unsecured obligations and all non-interest-bearing transactions 
deposits. The Treasury--in concert with the Federal Reserve and the 
FDIC--provided packages of loans and guarantees to ensure the continued 
stability of Citigroup and Bank of America, two of the world's largest 
banks. Over this period, governments in many foreign countries also 
announced plans to stabilize their financial institutions, including 
through large-scale capital injections, expansions of deposit 
insurance, and guarantees of some forms of bank debt.
    Faced with the significant deterioration in financial market 
conditions and a substantial worsening of the economic outlook, the 
Federal Open Market Committee (FOMC) continued to ease monetary policy 
aggressively in the final months of 2008, including a rate cut 
coordinated with five other major central banks. In December the FOMC 
brought its target for the federal funds rate to a historically low 
range of 0 to \1/4\ percent, where it remains today. The FOMC 
anticipates that economic conditions are likely to warrant 
exceptionally low levels of the Federal funds rate for some time.
    With the Federal funds rate near its floor, the Federal Reserve has 
taken additional steps to ease credit conditions. To support housing 
markets and economic activity more broadly, and to improve mortgage 
market functioning, the Federal Reserve has begun to purchase large 
amounts of agency debt and agency mortgage-backed securities. Since the 
announcement of this program last November, the conforming fixed 
mortgage rate has fallen nearly 1 percentage point. The Federal Reserve 
also established new lending facilities and expanded existing 
facilities to enhance the flow of credit to businesses and households. 
In response to heightened stress in bank funding markets, we increased 
the size of the Term Auction Facility to help ensure that banks could 
obtain the funds they need to provide credit to their customers, and we 
expanded our network of swap lines with foreign central banks to ease 
conditions in interconnected dollar funding markets at home and abroad. 
We also established new lending facilities to support the functioning 
of the commercial paper market and to ease pressures on money market 
mutual funds. In an effort to restart securitization markets to support 
the extension of credit to consumers and small businesses, we joined 
with the Treasury to announce the Term Asset-Backed Securities Loan 
Facility (TALF). The TALF is expected to begin extending loans soon.
    The measures taken by the Federal Reserve, other U.S. Government 
entities, and foreign governments since September have helped to 
restore a degree of stability to some financial markets. In particular, 
strains in short-term funding markets have eased notably since the 
fall, and London interbank offered rates (Libor)--upon which borrowing 
costs for many households and businesses are based--have decreased 
sharply. Conditions in the commercial paper market also have improved, 
even for lower-rated borrowers, and the sharp outflows from money 
market mutual funds seen in September have been replaced by modest 
inflows. Corporate risk spreads have declined somewhat from 
extraordinarily high levels, although these spreads remain elevated by 
historical standards. Likely spurred by the improvements in pricing and 
liquidity, issuance of investment-grade corporate bonds has been 
strong, and speculative-grade issuance, which was near zero in the 
fourth quarter, has picked up somewhat. As I mentioned earlier, 
conforming fixed mortgage rates for households have declined. 
Nevertheless, despite these favorable developments, significant 
stresses persist in many markets. Notably, most securitization markets 
remain shut, other than that for conforming mortgages, and some 
financial institutions remain under pressure.
    In light of ongoing concerns over the health of financial 
institutions, the Secretary of the Treasury recently announced a plan 
for further actions. This plan includes four principal elements: First, 
a new capital assistance program will be established to ensure that 
banks have adequate buffers of high-quality capital, based on the 
results of comprehensive stress tests to be conducted by the financial 
regulators, including the Federal Reserve. Second is a public-private 
investment fund in which private capital will be leveraged with public 
funds to purchase legacy assets from financial institutions. Third, the 
Federal Reserve, using capital provided by the Treasury, plans to 
expand the size and scope of the TALF to include securities backed by 
commercial real estate loans and potentially other types of asset-
backed securities as well. Fourth, the plan includes a range of 
measures to help prevent unnecessary foreclosures. Together, over time 
these initiatives should further stabilize our financial institutions 
and markets, improving confidence and helping to restore the flow of 
credit needed to promote economic recovery.
Federal Reserve Transparency
    The Federal Reserve is committed to keeping the Congress and the 
public informed about its lending programs and balance sheet. For 
example, we continue to add to the information shown in the Fed's H.4.1 
statistical release, which provides weekly detail on the balance sheet 
and the amounts outstanding for each of the Federal Reserve's lending 
facilities. Extensive additional information about each of the Federal 
Reserve's lending programs is available online. \1\The Fed also 
provides bimonthly reports to the Congress on each of its programs that 
rely on the section 13(3) authorities. Generally, our disclosure 
policies reflect the current best practices of major central banks 
around the world. In addition, the Federal Reserve's internal controls 
and management practices are closely monitored by an independent 
inspector general, outside private-sector auditors, and internal 
management and operations divisions, and through periodic reviews by 
the Government Accountability Office.
---------------------------------------------------------------------------
     \1\  For links and references, see Ben S. Bernanke (2009), 
``Federal Reserve Programs to Strengthen Credit Markets and the 
Economy,'' testimony before the Committee on Financial Services, U.S. 
House of Representatives, February 10, http://www.federalreserve.gov/
newsevents/testimony/bernanke20090210a.htm
---------------------------------------------------------------------------
    All that said, we recognize that recent developments have led to a 
substantial increase in the public's interest in the Fed's programs and 
balance sheet. For this reason, we at the Fed have begun a thorough 
review of our disclosure policies and the effectiveness of our 
communication. Today I would like to highlight two initiatives.
    First, to improve public access to information concerning Fed 
policies and programs, we recently unveiled a new section of our Web 
site that brings together in a systematic and comprehensive way the 
full range of information that the Federal Reserve already makes 
available, supplemented by explanations, discussions, and analyses. \2\ 
We will use that Web site as one means of keeping the public and the 
Congress fully informed about Fed programs.
---------------------------------------------------------------------------
     \2\  The Web site is located at http://www.federalreserve.gov/
monetarypolicy/bst.htm
---------------------------------------------------------------------------
    Second, at my request, Board Vice Chairman Donald Kohn is leading a 
committee that will review our current publications and disclosure 
policies relating to the Fed's balance sheet and lending policies. The 
presumption of the committee will be that the public has a right to 
know, and that the nondisclosure of information must be affirmatively 
justified by clearly articulated criteria for confidentiality, based on 
factors such as reasonable claims to privacy, the confidentiality of 
supervisory information, and the need to ensure the effectiveness of 
policy.
The Economic Outlook and the FOMC's Quarterly Projections
    In their economic projections for the January FOMC meeting, 
monetary policy makers substantially marked down their forecasts for 
real GDP this year relative to the forecasts they had prepared in 
October. The central tendency of their most recent projections for real 
GDP implies a decline of \1/2\ percent to 1\1/4\ percent over the four 
quarters of 2009. These projections reflect an expected significant 
contraction in the first half of this year combined with an anticipated 
gradual resumption of growth in the second half. The central tendency 
for the unemployment rate in the fourth quarter of 2009 was marked up 
to a range of 8\1/2\ percent to 8\3/4\ percent. Federal Reserve 
policymakers continued to expect moderate expansion next year, with a 
central tendency of 2\1/2\ percent to 3\1/4\ percent growth in real GDP 
and a decline in the unemployment rate by the end of 2010 to a central 
tendency of 8 percent to 8\1/4\ percent. FOMC participants marked down 
their projections for overall inflation in 2009 to a central tendency 
of \1/4\ percent to 1 percent, reflecting expected weakness in 
commodity prices and the disinflationary effects of significant 
economic slack. The projections for core inflation also were marked 
down, to a central tendency bracketing 1 percent. Both overall and core 
inflation are expected to remain low over the next 2 years.
    This outlook for economic activity is subject to considerable 
uncertainty, and I believe that, overall, the downside risks probably 
outweigh those on the upside. One risk arises from the global nature of 
the slowdown, which could adversely affect U.S. exports and financial 
conditions to an even greater degree than currently expected. Another 
risk derives from the destructive power of the so-called adverse 
feedback loop, in which weakening economic and financial conditions 
become mutually reinforcing. To break the adverse feedback loop, it is 
essential that we continue to complement fiscal stimulus with strong 
government action to stabilize financial institutions and financial 
markets. If actions taken by the Administration, the Congress, and the 
Federal Reserve are successful in restoring some measure of financial 
stability--and only if that is the case, in my view--there is a 
reasonable prospect that the current recession will end in 2009 and 
that 2010 will be a year of recovery. If financial conditions improve, 
the economy will be increasingly supported by fiscal and monetary 
stimulus, the salutary effects of the steep decline in energy prices 
since last summer, and the better alignment of business inventories and 
final sales, as well as the increased availability of credit.
    To further increase the information conveyed by the quarterly 
projections, FOMC participants agreed in January to begin publishing 
their estimates of the values to which they expect key economic 
variables to converge over the longer run (say, at a horizon of 5 or 6 
years), under the assumption of appropriate monetary policy and in the 
absence of new shocks to the economy. The central tendency for the 
participants' estimates of the longer-run growth rate of real GDP is 
2\1/2\ percent to 2\3/4\ percent; the central tendency for the longer-
run rate of unemployment is 4\3/4\ percent to 5 percent; and the 
central tendency for the longer-run rate of inflation is 1\3/4\ percent 
to 2 percent, with the majority of participants looking for 2 percent 
inflation in the long run. These values are all notably different from 
the central tendencies of the projections for 2010 and 2011, reflecting 
the view of policymakers that a full recovery of the economy from the 
current recession is likely to take more than 2 or 3 years.
    The longer-run projections for output growth and unemployment may 
be interpreted as the Committee's estimates of the rate of growth of 
output and the unemployment rate that are sustainable in the long run 
in the United States, taking into account important influences such as 
the trend growth rates of productivity and the labor force, 
improvements in worker education and skills, the efficiency of the 
labor market at matching workers and jobs, government policies 
affecting technological development or the labor market, and other 
factors. The longer-run projections of inflation may be interpreted, in 
turn, as the rate of inflation that FOMC participants see as most 
consistent with the dual mandate given to it by the Congress--that is, 
the rate of inflation that promotes maximum sustainable employment 
while also delivering reasonable price stability. This further 
extension of the quarterly projections should provide the public a 
clearer picture of the FOMC's policy strategy for promoting maximum 
employment and price stability over time. Also, increased clarity about 
the FOMC's views regarding longer-run inflation should help to better 
stabilize the public's inflation expectations, thus contributing to 
keeping actual inflation from rising too high or falling too low.
    At the time of our last Monetary Policy Report, the Federal Reserve 
was confronted with both high inflation and rising unemployment. Since 
that report, however, inflation pressures have receded dramatically 
while the rise in the unemployment rate has accelerated and financial 
conditions have deteriorated. In light of these developments, the 
Federal Reserve is committed to using all available tools to stimulate 
economic activity and to improve financial market functioning. Toward 
that end, we have reduced the target for the Federal funds rate close 
to zero and we have established a number of programs to increase the 
flow of credit to key sectors of the economy. We believe that these 
actions, combined with the broad range of other fiscal and financial 
measures being put in place, will contribute to a gradual resumption of 
economic growth and improvement in labor market conditions in a context 
of low inflation. We will continue to work closely with the Congress 
and the Administration to explore means of fulfilling our mission of 
promoting maximum employment and price stability.
        RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY
                      FROM BEN S. BERNANKE

Q.1. The Federal Reserve announced the creation of a $200 
billion Term Asset-Backed Securities Loan Facility in November 
2008. Just 2 weeks ago, the Federal Reserve in conjunction with 
the Treasury Department, announced the expansion of the program 
to up to $1 trillion and the possible expansion of eligible 
collateral.
    Given that we have not yet seen the first part of the 
program be an operational success, why did the Federal Reserve 
feel that it was necessary to announce an expansion of both 
volume and scope?
    Why should we be convinced that this program is the most 
effective mechanism to unthaw securitization markets? Do we 
have a true understanding of why investors have pulled away to 
the degree they have? And if we don't know the reason, then how 
can we expect to design an appropriate remedy?

A.1. The Term Asset-Backed Securities Loan Facility (TALF) was 
initially announced on November 25, 2008. In its initial stage, 
eligible collateral for TALF loans included AAA-rated newly 
issued asset-backed securities (ABS) backed by student loans, 
auto loans, credit card loans, and Small Business 
Administration (SBA) guaranteed loan.
    The first TALF operation took place on March 17, 2009. The 
4 months between announcement and operation reflected in part 
the time necessary to design the operational infrastructure of 
the program, but during that period the Federal Reserve also 
consulted with investors, issuers, and rating agencies about 
the asset classes included as eligible collateral as we 
developed the specific terms and conditions for the program.
    The initial set of eligible collateral was chosen with a 
view toward increasing the availability of credit to small 
businesses and households. The initial $200 billion ceiling for 
the program reflected our estimate of the likely activity with 
the approved collateral list over the announced period of 
operation--through December 31, 2009.
    The dysfunction in the asset-backed securities markets has 
had adverse effects on credit markets other than those for 
consumer and small business credit. For example, secondary 
markets for securities backed by commercial and nonconforming 
residential mortgages have been experiencing severe strain, and 
the availability of other certain types of business credit that 
has often been securitized in the past has diminished greatly. 
The announced expansion of the program is intended to 
facilitate issuance of securities backed by loans to those 
other sectors. We recognized that in order to accommodate the 
potential lending against the broader set of collateral, an 
increase in the overall size of the facility could be 
necessary.
    The announcement of the expansion preceded the first 
initial operation because of the urgency of encouraging lending 
to these other sectors. Our announcement that consideration was 
being given to expanding the facility likely provided some 
additional support, at the margin, for the residential and 
commercial mortgage-backed securities markets. Also, given the 
considerable lead time that it takes to develop terms and 
conditions for each asset class that both encourage ABS 
issuance and protect the taxpayer, it was important to announce 
the possible expansions as quickly as possible.
    The abrupt decline in new issuance of ABS reflected in 
large part two developments. First, the availability of 
leverage to ABS investors has contracted significantly because 
of the balance-sheet constraints now being faced by many major 
banking firms. Second, many traditional investors in AAA 
tranches of ABS have exited the market because of concern about 
the possibility of a severe recession and a sharp rise in 
defaults on loans to business and households. The TALF provides 
leverage to encourage new investors to purchase ABS. In 
addition, because the loans are provided on a non-recourse 
basis, the facility limits the potential losses of the 
investors to the amount by which the value of the ABS financed 
by the TALF loan exceeded the loan amount (the haircut). 
Although those haircuts have been chosen to reduce to only 
negligible levels the odds that the government will incur a 
loss on the facility overall, the program provides a degree of 
downside protection for investors on each asset financed.

Q.2. According to information already released, the Term Asset-
Backed Securities Lending Facility (TALF) will only accept 
newly originated assets and would require the credit rating 
agencies to rate the underlying securities. This system seems 
to attempt to mirror the general structure of the 
securitization market. There is concern, however, that the same 
credit rating agencies who were responsible for placing a 
``AAA'' rating on now toxic structured products will be relied 
on once again to rate these securities.
    What steps is the Federal Reserve taking to ensure that 
underlying assets are appropriately underwritten?
    Is the Fed prepared to dictate the terms to ensure that 
these loans, at minimum, comply with federal underwriting 
guidelines?

A.2. The Federal Reserve has discussed with the rating agencies 
the methodologies that they follow to rate the ABS accepted as 
collateral at the program. In general, rating agencies have 
taken steps that have led to tighter underwriting standards and 
stricter ratings criteria. In addition, the Federal Reserve 
requires that each ABS issuer hire an external auditor that 
must provide an opinion, using examination standards, that 
management's assertions concerning key collateral eligibility 
requirements are fairly stated in all material respect.
    TALF investors also serve an important ongoing role in 
price discovery and assessing risk through their ability to 
demand greater credit enhancements or price concessions. In 
particular, the sale of securities through TALF in an arms-
length transaction is an independent check not only on the 
underwriting practices of the issuer, but also of the efficacy 
of rating agency methodologies.
    There are no Federal underwriting standards for the loans 
backing the collateral accepted at the TALF. The TALF does not 
currently accept collateral backed by home mortgages. If 
residential mortgage-backed securities were to become eligible 
collateral for the TALF, we would require that the loans 
backing the securities comply with Federal underwriting 
standards.

Q.3. Your testimony notes that the United States has no well-
specified set of rules for dealing with the potential failure 
of a systemically critical non-depository financial 
institution. I would agree that we need to address the too-big-
to-fail issue, both for banks and other financial institutions. 
You have suggested the need for a resolution regime that allows 
the government to have a pre-defined process for resolving a 
non-bank financial firm that is systemically critical.
    Are you suggesting that non-bank financial firms must be 
dealt with in a manner other than changes to the bankruptcy 
process; that is, do we have to go to a receiver-like approach 
similar to FDIC?
    If so, how do we deal with the moral hazard implications?
    If not, what are other tools we could look at to address 
the current lack of resolution regime?

A.3. Although the Bankruptcy Code works well in the vast 
majority of situations, it is not designed to mitigate systemic 
consequences and, in some cases, the bankruptcy process may 
exacerbate the shocks to the financial system that may result 
from the failure of a systemically important nonbank financial 
institution. For example, the delays in the bankruptcy process 
that are designed to give the debtor ``breathing room'' to 
develop and propose a reorganization plan can be especially 
harmful to financial firms because uncertainty with respect to 
any large financial firm can have negative consequences for 
financial markets which are compounded as the uncertainty 
persists. In addition, the bankruptcy process does not 
currently provide a clear mechanism for the government to 
ensure that the institution is resolved in a way that achieves 
financial market stability and limits costs to taxpayers. 
Congress has in the past established alternative resolution 
regimes outside of the Bankruptcy Code for financial 
institutions where the public has a strong interest in managing 
and ensuring an orderly resolution process, such as in the 
Federal Deposit Insurance Act for insured depository 
institutions and in the Housing and Economic Recovery Act for 
government-sponsored enterprises. As I have indicated, these 
frameworks can serve as a useful model for developing a 
framework for the resolution of systemically important nonbank 
financial institutions.
    The issue of moral hazard is an extremely important 
consideration in developing any such regime for resolving 
systemically important nonbank financial institutions. Any 
proposed regime must carefully balance the need for swift and 
comprehensive government action to avoid systemic risk against 
the need to avoid creating moral hazard on the part of the 
large institutions that would be subject to the regime. A 
proposed regime could require a very high standard for invoking 
the resolution authority, because of the potential cost and to 
mitigate moral hazard. The process to invoke the authority 
could also include appropriate checks and balances, including 
input from multiple parts of the government, to ensure that it 
is invoked only when necessary while still maintaining the 
ability to act swiftly when needed to minimize systemic risk. 
The systemic risk exception to the least-cost resolution 
requirements of the Federal Deposit Insurance Act could provide 
a good example of the embodiment of such a process in existing 
law. Importantly, the establishment of a new resolution process 
for systemically important nonbank financial institutions may 
help reduce moral hazard by providing the government with the 
tools needed to resolve even the largest financial institutions 
in a way that both addresses systemic risks and allows the 
government to impose haircuts on creditors in appropriate 
circumstances. While a new framework for systemically important 
nonbank financial institutions is a critical component of any 
agenda to address systemic risk and the too-big-to-fail 
problem, other steps also need to be taken to address these 
issues. These include ensuring that all systemically important 
nonbank financial institutions are subject to a robust 
framework for consolidated supervision; strengthening the 
financial infrastructure; and providing the Federal Reserve 
explicit authority to oversee systemically important payment, 
clearing and settlement systems for prudential purposes.

Q.4. The Obama administration, along with several of my 
colleagues here in the Senate, have proposed allowing 
bankruptcy judges to cramdown the value of mortgages to reflect 
declines in home prices. The Federal Reserve, primarily through 
its purchases of GSE MBS, is becoming one of the largest 
holders of residential MBS.
    Has the Federal Reserve estimated the size of potential 
losses to the Fed's MBS holdings, if judges were allowed to 
cramdown mortgages?
    What signal do you believe this sends to potential 
investors in MBS, were Congress to re-write the contractual 
environment underlying these mortgages?

A.4. As noted by your question, the vast majority of mortgage-
backed securities (MBS) held by the Federal Reserve are agency 
MBS. The payment of principal and interest on agency MBS is 
guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae. 
Bankruptcy cramdowns do not affect investors in MBS guaranteed 
by Fannie Mae, Freddie Mac, or Ginnie Mae because the agency 
MBS investors would be made whole by the government-sponsored 
enterprises. Thus, the Federal Reserve holdings of agency MBS 
would not be affected by bankruptcy cramdowns for mortgages, 
although such legislation might have negative consequences for 
Fannie Mae, Freddie Mac, and the Federal Housing Administration 
(FHA). (The FHA insures the mortgages securitized by Ginnie 
Mae.)
    Private-label MBS are governed by trust agreements. Some 
private-label MBS contain so-called ``bankruptcy carve-out'' 
provisions requiring that losses stemming from bankruptcies be 
shared across the different tranches of the securities. The 
implication is that the investors holding the AAA-rated 
tranches would bear some of the losses from these principal 
write-downs, depending on the nature of the trusts agreements. 
The Federal Reserve has made loans to support its Maiden Lane 
Facilities, which were used to offset the systemic risks 
associated with recent financial market disruptions. Among the 
collateral for these loans are AAA-rated tranches of private-
label securities, as well as some collateralized debt 
obligations (CDOs) that are backed by AAA-rated tranches of 
private-label securities. At present, our assessment is that 
the possible loss associated with these MBS holdings from 
possible bankruptcy cramdown legislation is relatively small.
    With respect to current mortgage borrowers, providing 
bankruptcy judges with the ability to adjust mortgage terms and 
reduce outstanding principal could potentially result in more 
sustainable mortgage obligations for some borrowers and thus 
help reduce preventable foreclosures. Such an approach has 
several advantages. In particular, because of the costs and 
stigma of filing for bankruptcy, mortgage borrowers who do not 
need help may be unlikely to turn to the bankruptcy system for 
relief. In addition, bankruptcy judges may also be able to 
assess the extent to which a borrower truly needs assistance. 
Moreover, because the bankruptcy system is already in place, 
this approach could be implemented with little financial outlay 
from the taxpayer.
    Whether mortgage cramdowns are advantageous in the long-run 
is less clear. Such cramdowns could potentially restrict access 
to mortgage credit for some borrowers, and might have 
implications for investors in other types of loans because of 
the change in the loan's relative status during the course of 
bankruptcy. Potential investors, either in private-label MBS 
investors or in other types of loans, might view these changes 
in the bankruptcy code as raising the costs associated with 
servicing defaulted borrowers in the future if investors 
perceived such changes as permanent and broad-ranging, or if 
these changes altered investors' expectations about the 
government's willingness to make similar changes in the future. 
In this case, mortgage cramdowns might have longer-lasting 
effects on credit availability, and possibly impose higher 
costs on future borrowers through higher interest rates and 
more stringent lending standards.

Q.5. In a recent speech, you stated that the Fed's new longer-
term projections of inflation should be interpreted as the rate 
of inflation that FOMC participants believe will promote 
maximum sustainable employment and reasonable price stability. 
Some commentators have said that central banks using a long-
term inflation target should incorporate the adverse 
consequences of asset-price bubbles in their deliberations.
    Does the FOMC presently incorporate the possibility of 
asset price bubbles during deliberations on the inflation 
target?
    Did the FOMC include asset price bubbles in past 
deliberations?

A.5. Conditions in financial markets, including the possibility 
that asset prices exceed fundamental values, are always 
discussed at FOMC meetings. High asset values tend to put 
upward pressure on economic activity and the broader price 
level. In order to achieve its mandated objectives, the FOMC 
may need to tighten policy when this pressure threatens to push 
inflation above desired levels. However, it is exceedingly 
difficult to judge in real time whether asset prices are 
deviating from their fundamental values. Indeed, if such a 
judgment were easy, bubbles would never happen. However, 
regardless of whether a bubble exists or not, the FOMC does 
factor in the effects of asset prices on the economy when it 
sets monetary policy. Generally speaking, this means that 
interest rates tend to rise when asset prices are increasing to 
offset the inflationary impact of high asset prices and that 
interest rates tend to fall after bubbles burst to offset the 
contractionary effects of falling asset prices on employment.

Q.6. I have some concerns about the pro-cyclicality of our 
present system of accounting and bank capital regulation. Some 
commentators have endorsed a concept requiring banks to hold 
more capital when good conditions prevail, and then allow banks 
to temporarily hold less capital in order to not restrict 
access to credit during a downturn. Advocates of this system 
believe that counter cyclical policies could reduce imbalances 
within financial markets and smooth the credit cycle itself.
    What do you see as the costs and benefits of adopting a 
more counter cyclical system of regulation?
    Do you see any circumstances under which the Federal 
Reserve would take a position on the merits of counter cyclical 
regulatory policy?

A.6. The Federal Reserve has long advocated the need for banks 
to maintain sufficient levels of capital so they can weather 
unexpected shocks without interrupting the provision of credit 
and other financial services to customers. Historically, the 
challenge has been translating this broad principle into 
regulatory and supervisory standards that are workable, 
balanced, and compatible with a level, competitive playing 
field, both domestically and internationally. Capital is a 
relatively costly source of funding for banks, and higher 
capital requirements for banks will tend to raise their costs 
relative to those of competitors. Against this cost, there is a 
need to balance the benefits of higher capital in terms of 
lower risk to the safety net and enhanced financial and 
economic stability. However, these benefits are more uncertain 
and difficult to quantify. Likewise, while most would agree 
that a bank should maintain capital commensurate with its 
underlying risk taking, the quantification of risk is imprecise 
and inherently subjective. There is also uncertainty regarding 
how financial markets would react to changes in the capital 
framework and, in particular, whether higher capital buffers 
accumulated in good times would simply result in higher de 
facto minimum standards during downturns. In the past, it has 
been difficult reaching agreement on major changes to the bank 
capital framework, reflecting different views on how best to 
deal with these uncertainties (e.g., Pillar 1 versus Pillar 2 
versus Pillar 3; hardwired formulas versus discretion; simple 
rules-of-thumb versus sophisticated risk models).
    Nevertheless, an international consensus appears to be 
emerging that the bank regulatory capital framework needs to be 
made more counter-cyclical, and such an initiative is currently 
being undertaken by the Basel Committee on Banking Supervision 
and Regulation. The Federal Reserve strongly supports and is 
actively involved in this initiative. While this effort faces 
many of the same challenges noted above, there is now greater 
appreciation of both the importance of promoting more counter-
cyclical capital policies at banks and, we believe, the need to 
find a workable way forward on this issue.
    The Federal Reserve also supports initiatives currently 
under way at the Financial Accounting Standards Board and the 
International Accounting Standards Board (consistent with the 
recommendations of the Financial Stability Forum, now Financial 
Stability Board) to consider improvements to loan loss 
provisioning standards. These improvements would consider a 
broader range of credit quality information over the economic 
cycle to recognize losses earlier in the cycle. Similar to the 
requirements for capital buffers, the requirements for 
provisions would need to be set at a practical level and 
calculated in a readily transparent manner. Ideally, the 
requirement would need to be applied internationally to have 
the desired effect. In addition, enhancements to the income tax 
code to allow greater deductibility of provisions in line with 
the accounting treatment would also aid in this effort.
                                ------                                


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

Q.1. I am very concerned that the Fed's tools could become 
limited and less flexible, and that the Fed's ability to 
stimulate the economy given an effective zero interest rate is 
hindered. What role will the Fed play going forward in our 
economic recovery?

A.1. The Federal Reserve does not lose its ability to provide 
macroeconomic stimulus when short-term interest rates are at 
zero. However, when rates are this low, monetary stimulus takes 
nontraditional forms. The Federal Reserve has announced many 
new programs over the past year-and-a-half to support the 
availability of credit and thus help buoy economic activity. 
These programs are helping to restore the flow of credit to 
banks, businesses, and consumers. They are also helping to keep 
long-term interest rates and mortgage rates at very low levels. 
The Federal Reserve will continue to use these tools as needed 
to help the economy recover and prevent inflation from falling 
to undesirably low levels.

Q.2. As part of the White House's new housing plan, the 
administration suggests changes to the bankruptcy law to allow 
judicial modification of home mortgages. Do you believe 
``cramdown'' could affect the value of mortgage backed 
securities and how they are rated? Will bank capital be 
impacted if ratings on securities change? Is it better for 
consumers to get a modification from their servicer or through 
bankruptcy?

A.2. The Federal Reserve Board and other banking agencies have 
encouraged federally regulated institutions to work 
constructively with residential borrowers at risk of default 
and to consider loan modifications and other prudent workout 
arrangements that avoid unnecessary foreclosures. Loss 
mitigation techniques, including loan modifications, that 
preserve homeownership are generally less costly than 
foreclosure, particularly when applied before default. Such 
arrangements that are consistent with safe and sound lending 
practices are generally in the long-term best interest of both 
the financial institution and the borrower. (See Statement on 
Loss Mitigation Strategies for Servicers of Residential 
Mortgages, released by banking agencies on September 5, 2007.)
    Modifications in these contexts would be voluntary on the 
part of the servicer or holder of the loan. Although various 
proposals have circulated regarding so-called ``cramdown,'' the 
common theme of the proposals would permit judicial 
modification of the mortgage contract in circumstances where 
the borrower has filed for bankruptcy. These proposals present 
a number of challenging and potentially competing issues that 
should be carefully weighed. These issues include whether 
borrower negotiation with the servicer or loan holder is a 
precondition to judicial modification, the impact on risk 
assessment of the underlying obligation by holders of mortgage 
loans, and the appropriateness of permitting modification 
decisions by parties other than the holders of the loan or 
their servicers. Whether a borrower would be better off with a 
modification from a servicer or through bankruptcy would depend 
on many factors including the circumstances of the individual 
borrower, the terms of the modification, and the conditions 
governing any judicial modification in a bankruptcy proceeding.
    In general, when a depository institution is a holder of a 
security, the capital of the institution would likely be 
affected if the security is downgraded. How bankruptcy would 
impact the servicer would depend in part on the securitization 
documents treatment of the mortgage loans affected by 
bankruptcies under the relevant pooling and servicing 
agreements and the obligations of the servicer with respect to 
those loans. In addition, because the terms that might govern 
judicial modification in a bankruptcy proceeding have not been 
established, it is not clear how the value of mortgage-backed 
securities in general would be affected by changes to the 
bankruptcy laws that would permit judicial modification of 
mortgages.

Q.3. There is pressure to move quickly and reform our financial 
regulatory structure. What areas should we address in the near 
future and which areas should we set aside until we realize the 
full cost of the economic fallout we are currently 
experiencing?

A.3. The experience over the past 2 years highlights the 
dangers that systemic risks may pose not only to financial 
institutions and markets, but also for workers, households, and 
non-financial Businesses. Accordingly, addressing systemic risk 
and the related problem of financial institutions that are too 
big to fail should receive priority attention from 
policymakers. In doing so, policymakers must pursue a 
multifaceted strategy that involves oversight of the financial 
system as a whole, and not just its individual components, in 
order to improve the resiliency of the system to potential 
systemic shocks.
    This strategy should, among other things, ensure a robust 
framework for consolidated supervision of all systemically 
important financial firms organized as holding companies. The 
current financial crisis has highlighted that risks to the 
financial system can arise not only in the banking sector, but 
also from the activities of financial firms, such as insurance 
firms and investment banks, that traditionally have not been 
subject to the type of consolidated supervision applied to bank 
holding companies. Broad-based application of the principle of 
consolidated supervision would also serve to eliminate gaps in 
oversight that would otherwise allow risk-taking to migrate 
from more-regulated to less-regulated sectors.
    In addition, a critical component of an agenda to address 
systemic risk and the too-big-to-fail problem is the 
development of a framework that allows the orderly resolution 
of a systemically important nonbank financial firm and includes 
a mechanism to cover the costs of such a resolution. In most 
cases, the Federal bankruptcy laws provide an appropriate 
framework for the resolution of nonbank financial institutions. 
However, the bankruptcy laws do not sufficiently protect the 
public's strong interest in ensuring the orderly resolution of 
nondepository financial institutions when a failure would pose 
substantial systemic risks. Besides reducing the potential for 
systemic spillover effects in case of a failure, improved 
resolution procedures for systemically important firms would 
help reduce the too-big-to-fail problem by narrowing the range 
of circumstances that might be expected to prompt government 
intervention to keep a firm operating.
    Policymakers and experts also should carefully review 
whether improvements can be made to the existing bankruptcy 
framework that would allow for a faster and more orderly 
resolution of financial firms generally. Such improvements 
could reduce the likelihood that the new alternative regime 
would need to be invoked or government assistance provided in a 
particular instance to protect financial stability and, 
thereby, could promote market discipline.
    Another component of an agenda to address systemic risks 
involves improvements in the financial infrastructure that 
supports key financial markets. The Federal Reserve, working in 
conjunction with the President's Working Group on Financial 
Markets, has been pursuing several initiatives designed to 
improve the functioning of the infrastructure supporting credit 
default swaps, other OTC derivatives, and tri-party repurchase 
agreements. Even with these initiatives, the Board believes 
additional statutory authority is needed to address the 
potential for systemic risk in payment and settlement systems. 
Currently, the Federal Reserve relies on a patchwork of 
authorities, largely derived from our role as a banking 
supervisor, as well as on moral suasion to help ensure that 
critical payment and settlement systems have the necessary 
procedures and controls in place to manage their risks. By 
contrast, many major central banks around the world have an 
explicit statutory basis for their oversight of these systems. 
Given how important robust payment and settlement systems are 
to financial stability, and the functional similarities between 
many such systems, a good case can be made for granting the 
Federal Reserve explicit oversight authority for systemically 
important payment and settlement systems.
    The Federal Reserve has significant expertise regarding the 
risks and appropriate risk-management practices at payment and 
settlement systems, substantial direct experience with the 
measures necessary for the safe and sound operation of such 
systems, and established working relationships with other 
central banks and regulators that we have used to promote the 
development of strong and internationally accepted risk 
management standards for the full range of these systems. 
Providing such authority would help ensure that these critical 
systems are held to consistent and high prudential standards 
aimed at mitigating systemic risk.
    Financial stability could be further enhanced by a more 
explicitly macroprudential approach to financial regulation and 
supervision in the United States. Macroprudential policies 
focus on risks to the financial system as a whole. Such risks 
may be crosscutting, affecting a number of firms and markets, 
or they may be concentrated in a few key areas. A 
macroprudential approach would complement and build on the 
current regulatory and supervisory structure, in which the 
primary focus is the safety and soundness of individual 
institutions and markets. One way to integrate a more 
macroprudential element into the U.S. supervisory and 
regulatory structure would be for the Congress to direct and 
empower a governmental authority to monitor, assess, and, if 
necessary, address potential systemic risks within the 
financial system.
    Such a systemic risk authority could, for example, be 
charged with (1) monitoring large or rapidly increasing 
exposures--such as to subprime mortgages--across firms and 
markets; (2) assessing the potential for deficiencies in 
evolving risk-management practices, broad-based increases in 
financial leverage, or changes in financial markets or products 
to increase systemic risks; (3) analyzing possible spillovers 
between financial firms or between firms and markets, for 
example through the mutual exposures of highly interconnected 
firms; (4) identifying possible regulatory gaps, including gaps 
in the protection of consumers and investors, that pose risks 
for the system as a whole; and (5) issuing periodic reports on 
the stability of the U.S. financial system, in order both to 
disseminate its own views and to elicit the considered views of 
others. A systemic risk authority likely would also need an 
appropriately calibrated ability to take measures to address 
identified systemic risks--in coordination with other 
supervisors, when possible, or independently, if necessary. The 
role of a systemic risk authority in the setting of standards 
for capital, liquidity, and risk-management practices for the 
financial sector also would need to be explored, given that 
these standards have both microprudential and macroprudential 
implications.

Q.4. How should the government and regulators look to mitigate 
the systemic risks posed by large interconnected financial 
companies? Do we risk distorting the market by identifying 
certain institutions as systemically important? Should the 
Federal Reserve step into the role as a systemic regulator or 
should this task be given to a different entity.

A.4. As discussed in response to Question 3, I believe there 
are several important steps that should be part of any agenda 
to mitigate systemic risks and address the problem caused by 
institutions that are viewed as being too big to fail. Some of 
these actions--such as an improved resolution framework--would 
be focused on systemically important financial institutions, 
that is, institutions the failure of which would pose 
substantial risks to financial stability and economic 
conditions. A primary--though not the sole focus--of a systemic 
risk authority also likely would include such financial 
institutions.
    Publicly identifying a small set of financial institutions 
as ``systemically important'' would pose certain risks and 
challenges. Explicitly and publicly identifying certain 
institutions as systemically important likely would weaken 
market discipline for these firms and could encourage them to 
take excessive risks--tendencies that would have to be counter-
acted by strong supervisory and regulatory policies. Similarly, 
absent countervailing policies, public designation of a small 
set of firms as systemically important could give the 
designated firms a competitive advantage relative to other 
firms because some potential customers might prefer to deal 
with firms that seem more likely to benefit from government 
support in times of stress. Of course, there also would be 
technical and policy issues associated with establishing the 
relevant criteria for identifying systemically important 
financial institutions especially given the broad range of 
activities, business models and structures of banking 
organizations, securities firms, insurance companies, and other 
financial institutions.
    Some commentators have proposed that the Federal Reserve 
take on the role of systemic risk authority; others have 
expressed concern that adding this responsibility might 
overburden the central bank. The extent to which this new 
responsibility might be a good match for the Federal Reserve 
depends a great deal on precisely how the Congress defines the 
role and responsibilities of the authority, as well as on how 
the necessary resources and expertise complement those employed 
by the Federal Reserve in the pursuit of its long-established 
core missions. As a practical matter, effectively identifying 
and addressing systemic risks would seem to require the 
involvement of the Federal Reserve in some capacity, even if 
not in the lead role. The Federal Reserve traditionally has 
played a key role in the government's response to financial 
crises because it serves as liquidity provider of last resort 
and has the broad expertise derived from its wide range of 
activities, including its role as umbrella supervisor for bank 
and financial holding companies and its active monitoring of 
capital markets in support of its monetary policy and financial 
stability objectives.

Q.5. The largest individual corporate bailout to date has not 
been a commercial bank, but an insurance company. What steps 
has the Federal Reserve taken to make sure AIG is not perceived 
as being guaranteed by the Federal government?

A.5. In light of the importance of the American International 
Group, Inc (AIG) to the stability of financial markets in the 
recent deterioration of financial markets and continued market 
turbulence generally, the Treasury and the Federal Reserve have 
stated their commitment to the orderly restructuring of the 
company and to work with AIG to maintain its ability to meet 
its obligations as they come due. In periodic reports to 
Congress submitted under section 129 of the Emergency Economic 
Stabilization Act of 2008, in public reports providing details 
on the Federal Reserve financial statements, and in testimony 
before Congress and other public statements, we have described 
in detail our relationship to AIG, which is that of a secured 
lender to the company and to certain special purpose vehicles 
related to the company. These disclosures include the essential 
terms of the credit extension, the amount of AIG's repayment 
obligation, and the fact that the Federal Reserve's exposure to 
AIG will be repaid through the proceeds of the company's 
disposition of many of its subsidiaries. Neither the Federal 
Reserve, nor the Treasury, which has purchased and committed to 
purchase preferred stock issued by AIG, has guaranteed AIG's 
obligations to its customers and counterparties.
    Moreover, the Government Accountability Office has inquired 
into whether Federal financial assistance has allowed AIG to 
charge prices for property and casualty insurance products that 
are inadequate to cover the risk assumed. Although the GAO has 
not drawn any final conclusions about how financial assistance 
to AIG has impacted the overall competitiveness of the property 
and casualty insurance market, the GAO reported that the state 
insurance regulators the GAO spoke with said they had seen no 
indications of inadequate pricing by AIG's commercial property 
and casualty insurers. The Pennsylvania Insurance Department 
separately reported that it had not seen any clear evidence of 
under-pricing of insurance products by AIG to date.

Q.6. Given the critical role of insurers in enabling credit 
transactions and insuring against every kind of potential loss, 
and the size and complexity of many insurance companies, do you 
believe that we can undertake serious market reform without 
establishing federal regulation of the insurance industry?

A.6. As noted above, ensuring that all systemically important 
financial institutions are subject to a robust framework--both 
in law and practice--for consolidated supervision is an 
important component of an agenda to address systemic risks and 
the too-big-to-fail problem. While the issue of a Federal 
charter for insurance is a complex one, it could be useful to 
create a Federal option for insurance companies, particularly 
for large, systemically important insurance companies.

Q.7. What effect do you believe the new Fed rules for credit 
cards will have on the consumer and on the credit card 
industry?

A.7. The final credit card rules are intended to allow 
consumers to access credit on terms that are fair and more 
easily understood. The rules seek to promote responsible use of 
credit cards through greater transparency in credit card 
pricing, including the elimination of pricing practices that 
are deceptive or unfair. Greater transparency will enhance 
competition in the marketplace and improve consumers' ability 
to find products that meet their needs From the perspective of 
credit card issuers, reduced reliance on penalty rate increases 
should spur efforts to improve upfront underwriting. While the 
Board cannot predict how issuers will respond, it is possible 
that some consumers will receive less credit than they do 
today. However, these rules will benefit consumers overall 
because they will be able to rely on the rates stated by the 
issuer and can therefore make informed decisions regarding the 
use of credit.

Q.8. The Fed's new credit card rules are not effective until 
July 2010. We have heard from some that this is too long and 
that legislation needs to be passed now to shorten this to a 
few months. Why did the Fed give the industry 18 months put the 
rules in place?

A.8. The final rules represent the most comprehensive and 
sweeping reforms ever adopted by the Board for credit card 
accounts and will apply to more than 1 billion accounts. Given 
the breadth of the changes, which affect most aspects of credit 
card lending, card issuers must be afforded ample time for 
implementation to allow for an orderly transition that avoids 
unintended consequences, compliance difficulties, and potential 
liabilities.

    To comply with the final rules, card issuers must 
        adopt different business models and pricing strategies 
        and then develop new credit products. Depending on how 
        business models evolve, card issuers may need to 
        restructure their funding mechanisms.

    In addition to these operational changes, issuers 
        must revise their marketing materials, application and 
        solicitation disclosures, credit agreements, and 
        periodic statements so that the documents reflect the 
        new products and conform to the rules.

    Changes to the issuers' business practices and 
        disclosures will involve extensive reprogramming of 
        automated systems which subsequently must be tested for 
        compliance, and personnel must receive appropriate 
        training.

    Although the Board has encouraged card issuers to make the 
necessary changes as soon as practicable, an 18-month 
compliance period is consistent with the nature and scope of 
the required changes.
                                ------                                


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

Q.1. Under the $700 billion TARP package and the recent $788 
billion stimulus bill, the Federal government is spending 
hundreds of billions of taxpayer dollars to support the 
financial institutions at the center of the economic storm. 
Many of these same companies are now targets of securities 
class action lawsuits seeking hundreds of billions of dollars. 
In fact, the companies that, to date, have received the most 
governmental assistance have been deluged with a wave of 
lawsuits--suits that typically duplicate ongoing enforcement 
investigations by Federal prosecutors and the SEC.

    I'm told that private securities class action 
        filings in 2008 reached their highest levels in 6 
        years; the number of filings increased almost 40 
        percent from the previous year.

    Also, financial institutions were named as 
        defendants in half of the new private class actions 
        filed in 2008 (Cornerstone Research, Securities Class 
        Action Filings, 2008: A Year in Review 2 (Jan. 6, 
        2009)) and nearly every single entity that has obtained 
        more than $100 million in governmental assistance is 
        already a defendant in one or more securities class 
        actions based on allegations related to the current 
        economic crisis.

    Almost 75 percent of the TARP funds expended have 
        gone to financial institutions named as defendants in 
        recent securities class actions.

    The huge costs associated with these lawsuits mean that 
billions of dollars in taxpayer funds will not be used to 
increase lending, but rather will be paid out in legal fees--
both plaintiff and defense--and lawsuit settlements. And 
taxpayers will be less likely to recover their investments in 
companies weakened by large costs imposed by these class 
actions.
    I strongly support government enforcement actions against 
wrongdoers, accompanied by stiff penalties. Federal prosecutors 
and the SEC today have broad power to initiate such actions; to 
the extent there are gaps in their authority, those gaps should 
be filled.
    But I wonder whether we should be doing something to guard 
against the risk that taxpayer dollars intended to support 
increased lending will be drained from TARP recipients by the 
tremendous legal expenses--including the high costs of 
settlement--caused by private securities class action lawsuits? 
Aren't these lawsuits effectively job destroyers by diverting 
the TARP funds from their job creating purposes--won't 
taxpayers have to invest still more money to reinvigorate 
lending to businesses and consumers? And won't the diversion of 
these funds mean an increased risk that taxpayers may not get 
their money back from some TARP-assisted institutions, or at 
least that the time for repayment will be longer?

A.1. The financial institutions that receive funds from the 
Troubled Asset Relief Program (TARP) continue to operate as 
private enterprises and continue to be subject to the same laws 
and regulations that apply to institutions that do not receive 
funds from the TARP. The institutions that have received TARP 
funds must bear any costs associated with compliance with 
applicable laws. Concerns about abusive practices in the filing 
of private lawsuits arising under the securities laws prompted 
Congress to enact litigation reform legislation several years 
ago. We believe that any additional legislative initiatives to 
consider securities litigation reform should cover all 
institutions that are subject to those laws.

Q.2. Chairman Bernanke, I want to thank you and the dedicated 
professionals at the Fed for all your hard work on the credit 
card rules--UDAP, Reg AA, Reg Z--released on December 18, 2008. 
As with several of my colleagues, we appreciate the delicate 
balance the Fed is trying to reach in protecting consumers 
against unfair practices while trying to make sure the 
regulations do not further limit the availability of credit.
    Along those lines, can you please provide for me background 
on the UDAP rule's impact on the ability of retailers in my 
state to offer ``no interest'' financing? I have heard from 
them that this financing option is very popular with 
consumers--especially now--and helps them be able to afford 
large ticket items like appliances, home repairs, computers, 
etc. Simply put, will retailers be able to continue to offer 
this type of financing option to their customers after the July 
1, 2010, effective date? What about the millions of accounts in 
place--some of which may expire after the effective date? I 
would appreciate the Fed working with retailers and credit 
providers to come up with a simple and fair way for them to 
offer ``no interest'' financing going forward. Thank you.

A.2. In the final rule addressing unfair and deceptive credit 
card practices, the Board, the Office of Thrift Supervision 
(OTS), and the National Credit Union Administration (NCUA) 
(collectively, the Agencies) expressed concern regarding 
deferred interest programs that are marketed as ``no interest'' 
but charge the consumer interest if purchases made under the 
program are not paid in full by a specified date or if the 
consumer violates the account terms prior to that date (which 
could include a ``hair trigger'' violation such as paying one 
day late). In particular, the Agencies noted that, although 
these programs provide substantial benefits to consumers who 
pay the purchases in full prior to the specified date, the ``no 
interest'' marketing claims may cause other consumers to be 
unfairly surprised by the increase in the cost of those 
purchases. Accordingly, the Agencies concluded that prohibiting 
deferred interest programs as they are currently marketed and 
structured would improve transparency and enable consumers to 
make more informed decisions regarding the cost of using 
credit.
    The Agencies specifically stated, however, that the final 
rule permits institutions to offer promotional programs that 
provide similar benefits to consumers but do not raise concerns 
about unfair surprise. For example, the Agencies noted that an 
institution could offer a program where interest is assessed on 
purchases at a disclosed rate for a period of time but the 
interest charged is waived or refunded if the principal is paid 
in full by the end of that period.
    The Board understands that the distinction in the final 
rule between ``deferred interest'' and ``waived or refunded 
interest'' has caused confusion regarding how institutions 
should structure these types of promotional programs where the 
consumer will not be obligated to pay interest that accrues on 
purchases if those purchases are paid in full by a specified 
date. For this reason, the Board is consulting with the OTS and 
NCUA regarding the need to clarify that the focus of the final 
rule is not on the technical aspects of these promotional 
programs (such as whether interest is deferred or waived) but 
instead on whether the programs are disclosed and structured in 
a way that consumers will not be unfairly surprised by the cost 
of using the programs. The Agencies are also considering 
whether clarification is needed regarding how existing deferred 
interest plans should be treated as of the final rule's July 1, 
2010, effective date. If the Agencies determine that 
clarifications to the final rule are necessary, those changes 
will assist institutions in understanding and complying with 
the new rules and should not reduce protections for consumers.
                                ------                                


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

Q.1. Chairman Bernanke, as you may know, I strongly support 
comprehensive credit card reform, including S. 414 introduced 
by Chairman Dodd which would strengthen and expedite (up from 
July 1, 2010) many of the provisions in the final UDAP-Reg AA-
Reg Z rule published last December by the Federal Reserve such 
as universal default, double-cycle billing, exorbitant 
overdraft fees, etc. S. 414 does not address the issue of 
``deferred interest'' or ``no interest'' financing but I 
understand the final UDAP rule does attempt to address it and 
the complexity of the issue has some retailers concerned. Can 
you please clarify for me the impact of this proposal on 
consumers and businesses who use ``no interest'' financing? I 
understand the impact to be very large and I would appreciate 
the Fed working with retailers to clarify that ``no interest'' 
financing can be used in the future albeit with revised 
disclosures and marketing.

A.1. In the final rule addressing unfair and deceptive credit 
card practices, the Board, the Office of Thrift Supervision 
(OTS), and the National Credit Union Administration (NCUA) 
(collectively, the Agencies) expressed concern regarding 
deferred interest programs that are marketed as ``no interest'' 
but charge the consumer interest if purchases made under the 
program are not paid in full by a specified date or if the 
consumer violates the account terms prior to that date (which 
could include a ``hair trigger'' violation such as paying one 
day late). In particular, the Agencies noted that, although 
these programs provide substantial benefits to consumers who 
pay the purchases in fill prior to the specified date, the ``no 
interest'' marketing claims may cause other consumers to be 
unfairly surprised by the increase in the cost of those 
purchases. Accordingly, the Agencies concluded that prohibiting 
deferred interest programs as they are currently marketed and 
structured would improve transparency and enable consumers to 
make more informed decisions regarding the cost of using 
credit.
    The Agencies specifically stated, however, that the final 
rule permits institutions to offer promotional programs that 
provide similar benefits to consumers but do not raise concerns 
about unfair surprise. For example, the Agencies noted that an 
institution could offer a program where interest is assessed on 
purchases at a disclosed rate for a period of time but the 
interest charged is waived or refunded if the principal is paid 
in full by the end of that period.
    The Board understands that the distinction in the final 
rule between ``deferred interest'' and ``waived or refunded 
interest'' has caused confusion regarding how institutions 
should structure these types of promotional programs where the 
consumer will not be obligated to pay interest that accrues on 
purchases if those purchases are paid in full by a specified 
date. For this reason, the Board is consulting with the OTS and 
NCUA regarding the need to clarify that the focus of the final 
rule is not on the technical aspects of these promotional 
programs (such as whether interest is deferred or waived) but 
instead on whether the programs are disclosed and structured in 
a way that consumers will not be unfairly surprised by the cost 
of using the programs. The Agencies are also considering 
whether clarification is needed regarding how existing deferred 
interest plans should be treated as of the final rule's July 1, 
2010, effective date. If the Agencies determine that 
clarifications to the final rule are necessary, those changes 
will assist institutions in understanding and complying with 
the new rules and should not reduce protections for consumers.
                                ------                                


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

Q.1. What is it going to take to encourage private investment 
in our banks and drawing private capital that is now on the 
sidelines to ensuring that our financial institutions are 
stable and that our capital markets can return to more normal 
and healthy functioning?

A.1. We believe that attracting private capital to recapitalize 
the financial industry is very important and steps to encourage 
private capital should be taken. Several factors have 
contributed to the reluctance of private capital providers from 
investing in financial institutions in recent months, including 
uncertainty about the health of financial institutions, broader 
macroeconomic and financial market conditions, and how private 
capital claims might be treated given existing or additional 
government support. The Federal Reserve has taken various 
actions to support financial market liquidity and economic 
activity, which are important steps to encourage private 
capital flows to the financial sector. In recent weeks, 
indicators of market and firm risks have fallen and share 
prices of financial institutions have risen, suggesting some 
reduction in investor uncertainty. In addition, a number of 
institutions have issued new equity shares following the 
release of the results of the Supervisory Capital Assessment 
Program in early May.

Q.2. To what extent do you believe that government and central 
bank policies led to the credit bubble?

A.2. The fundamental causes of the ongoing financial turmoil 
remain in dispute. In my view, however, it is impossible to 
understand this crisis without reference to the global 
imbalances in trade and capital flows that began in the latter 
half of the 1990s. In the simplest terms, these imbalances 
reflected a chronic lack of saving relative to investment in 
the United States and some other industrial countries, combined 
with an extraordinary increase in saving relative to investment 
in many emerging market nations. The increase in excess saving 
in the emerging world resulted in turn from factors such as 
rapid economic growth in high-saving East Asian economies 
accompanied, outside of China, by reduced investment rates; 
large buildups in foreign exchange reserves in a number of 
emerging markets; and substantial increases in revenues 
received by exporters of oil and other commodities. Saving 
flowed from where it was abundant to where it was deficient, 
with the result that the United States and some other advanced 
countries experienced large capital inflows for more than a 
decade, even as real long-term interest rates (both here and 
abroad) remained low.
    These capital inflows and low global interest rates 
interacted with the U.S. housing market and overall financial 
system in ways that eventually proved to be dysfunctional. As 
outlined in a report by the President's Working Group on 
Financial Markets (PWG) released last year, \1\ the most 
evident of those was clearly a breakdown in underwriting 
standards for subprime mortgages. But that was symptomatic of a 
much broader erosion of market discipline: Competition and the 
desire to maintain high returns created significant demand for 
structured credit product by investors, and all market 
participants involved in the securitization process, including 
originators, underwriters, asset managers, credit rating 
agencies, and global investors, failed to obtain sufficient 
information or to conduct comprehensive risk assessments on 
instruments that were quite complex. Investors relied 
excessively on credit ratings, and rating agencies relied on 
faulty assumptions to produce those ratings. These developments 
revealed serious weaknesses in risk management practices at 
several large U.S. and European financial institutions (some of 
which were widely perceived to be ``too big to fail''), 
especially with respect to the concentration of risks, the 
valuation of illiquid instruments, the pricing of contingent 
liquidity facilities, and the management of liquidity risk.
---------------------------------------------------------------------------
     \1\ Policy Statement on Financial Market Developments by the 
President's Working Group on Financial Markets, March 13, 2008.
---------------------------------------------------------------------------
    In some cases, regulatory policies failed to mitigate those 
risk management weaknesses. For example, existing capital 
requirements encouraged the securitization of assets through 
facilities with very low capital requirements and failed to 
provide adequate incentives for firms to maintain capital and 
liquidity buffers sufficient to absorb extreme systemwide 
shocks. Further, supervisory authorities did not insist on 
appropriate disclosures of firms' potential exposure to off-
balance sheet vehicles.
    To address these weaknesses, I believe reforms to the 
financial architecture are needed to help prevent a similar 
crisis to develop in the future. First, the problem of 
financial firms that are considered too big, or perhaps too 
interconnected, to fail must be addressed. This perception 
reduces market discipline, encourages excessive risk taking by 
the firms, and creates the incentive for any firm to grow in 
order to be perceived as too big to fail.
    Second, the financial infrastructure, including the 
systems, rules, and conventions that govern trading, payment, 
clearing, and settlement in financial markets, needs to be 
strengthened. In this respect, the aim should be not only to 
make the financial system as a whole better able to withstand 
future shocks, but also to mitigate moral hazard and the 
problem of too big to fail by reducing the range of 
circumstances in which systemic stability concerns might prompt 
government intervention. Third, a review of regulatory policies 
and accounting rules is desirable to ensure that they do not 
induce excessive procyclicality--that is, do not overly magnify 
the ups and downs in the financial system and the economy. And 
finally, consideration should be given to the creation of an 
authority specifically charged with monitoring and addressing 
systemic risk, with the objective of helping to protect the 
system from financial crises like the one we are currently 
experiencing.
    Reforming the structure of the financial system would go a 
long way towards mitigating the risk that other severe episodes 
of financial instability would arise in the future. Reducing 
this risk would in turn allow the Federal Reserve to continue 
to direct monetary policy towards the pursuit of the goals for 
which it is best suited--the legislated objectives of maximum 
employment, stable prices, and moderate long-term interest 
rates. With hindsight, an argument could be made, and has been 
made by some, that tighter monetary policy earlier in the 
decade might have helped limit the rise in house prices and 
checked the development of the subprime mortgage market, 
thereby containing the damage to the economy that later 
occurred when the housing market collapsed. However, the rise 
in the Federal funds rate required to accomplish this task 
would likely have had to be quite large, and thus would have 
significantly impaired economic growth, boosted unemployment, 
and probably led to an undesirably low rate of core inflation. 
All those would have been outcomes clearly at odds with the 
Federal Reserve's objectives. Rather than redirecting monetary 
policy in this manner, a better approach going forward would be 
to have a stronger supervisory system in place to greatly 
reduce the risk that credit bubbles will merge in the first 
place, or at least to contain their expansion and limit the 
fallout from their eventual collapse. This would significantly 
help in the prevention of financial crises like the current one 
while at the same time still allowing macroeconomic performance 
to be as strong as earlier in the decade.

Q.3. At what point does an institution or a product pose 
systemic risk?

A.3. Identifying whether a given institution's failure is 
likely to impose systemic risks on the U.S. financial system 
and our overall economy is a very complex task that inevitably 
depends on the specific circumstances of a given situation and 
requires substantial judgment by policymakers. That being said, 
a number of key principles should guide policymaking in this 
area.
    First, no firm should be considered too big to fail in the 
sense that existing stockholders cannot be wiped out, existing 
senior management and boards of directors cannot be replaced, 
and over time the organization cannot be wound down or sold in 
whole or in part. In addition, from the point of view of 
maintaining financial stability, it is critical that such a 
wind down occur in an orderly manner. Unfortunately, the 
current resolution process for systemically important nonbank 
financial institutions does not facilitate such a wind down, 
and thus my testimony's recommendation for improved resolution 
procedures for potentially systemic financial firms. Still, 
even without improved procedures, it is important to try to 
resolve the firm in an orderly manner without guaranteeing the 
longer-term existence of any individual firm.
    Second, and as I indicated in my statement, the core 
concern of policymakers is whether the failure of the firm 
would be likely to have contagion, or knock-on, effects on 
other key financial institutions and markets and ultimately on 
the real economy. Thus, in making a systemic risk 
determination, we look as carefully as we can at the 
interconnections, or interdependencies, between the failing 
firm and other participants in the financial system and the 
implications for these other participants of the troubled 
firm's failure. Such interdependencies can be direct, such as 
through deposit and loan relationships, or indirect, such as 
through concentrations in similar types of assets. 
Interdependencies can extend to broader financial markets and 
can also be transmitted through payment and settlement systems. 
In addition, we consider the extent to which the failure of the 
firm and other interconnected firms would affect the real 
economy through, for example, a sharp reduction in the supply 
of credit, rapid declines in the prices of key financial and 
nonfinancial assets, or a large drop in the sense of confidence 
that financial market participants, households, and 
nonfinancial businesses bring to their activities. Of course, 
contagion effects are typically more likely in the case of a 
very large institution than with a smaller institution. 
However, I would emphasize that size is far from the only 
criterion for determining whether a firm is potentially 
systemic. Moderate-sized, or even relatively small firms, could 
be systemic if, in a given situation, a firm is critical to the 
functioning of key markets or, for example, critical payment 
and settlement systems. I would also reiterate that while 
traditionally the concern was that a run on a troubled bank 
could inspire contagious runs on other banks, recent financial 
crises have shown us that systemic risks can arise in other 
financial institutions and markets. For example, we now 
understand that highly destabilizing runs can occur on 
investment banks and money market funds.
    Third, the nature of the overall financial and economic 
environment is a core factor in deciding whether a given 
institution's failure is likely to impose systemic risks. If 
the overall environment is highly uncertain and troubled, as 
was clearly the case last fall, then the likelihood of systemic 
effects is typically much greater than if the economy is 
growing and market participants are generally optimistic and 
confident about the future. Indeed, and as I indicated above, 
the potential effects of a firm's failure on the confidence of 
not only financial market participants, but a wide spectrum of 
households and businesses is a key decision variable in 
policymakers' assessment of whether a given firm's failure is 
likely to pose systemic risks.

Q.4. In a statement Monday, AIG said it is continuing to work 
with the government to evaluate potential new alternatives for 
addressing AIG's financial challenges. AIG's rescue package has 
already been increased twice since September, from $85 billion 
to nearly $123 billion in October and then to $150 billion in 
November. According to today's WSJ, AIG is seeking an overhaul 
of its $150 billion government bailout package that would 
substantially reduce the insurer's financial burden, while 
further exposing U.S. taxpayers to its fortunes. Are you and 
Treasury considering changing our approach to AIG from that of 
a creditor to one of a potential owner?

A.4. As explained in the reports submitted to Congress under 
section 129 of the Emergency Economic Stabilization Act of 
2008, the Federal Reserve, in conjunction with the Treasury 
Department, has taken a series of steps since September 2008, 
to address the liquidity and capital needs of the American 
International Group, Inc. (AIG) and thereby to help stabilize 
the company, prevent a disorderly failure, and protect 
financial stability, which is a prerequisite to resumption of 
economic activity. In particular, in September and November 
2008, the Federal Reserve established several credit 
facilities, including a Revolving Credit Facility, to further 
these objectives. As part of the November restructuring, the 
Treasury purchased $40 billion in AIG preferred stock.
    In light of the significant challenges faced by AIG in the 
last months of 2008 and the continued risk it poses to the 
financial system, on March 2, 2009, the Federal Reserve and the 
Treasury announced a restructuring of the government's 
assistance to the company. The March actions announced by the 
Federal Reserve include partial repayment of the Revolving 
Credit Facility with preferred stock interests in two of AIG's 
life insurance subsidiaries and with the proceeds of new loans 
that would be secured by net cash flows from designated blocks 
of existing life insurance policies held by other life 
insurance subsidiaries of AIG. These actions were undertaken in 
the context of the Federal Reserve's role as a creditor of AIG. 
As part of the March restructuring, the Treasury established a 
capital facility that allows AIG to draw down up to 
approximately $30 billion as needed over time in exchange for 
additional preferred stock. For more detail, please see Federal 
Reserve System Monthly Report on Credit and Liquidity Programs 
and The Balance Sheet (June 2009) at 13-16, http://
www.federalreserve.gov/monetarypolicy/files/
monthlyclbsreport200906.pdf.

Q.5. Recent events in the credit markets have highlighted the 
need for greater attention to settling credit default swaps by 
creating a central clearing system. While central counterparty 
clearing and exchange trading of relatively standardized 
contracts have the potential to reduce risk and increase market 
efficiency, market participants must be permitted to continue 
to negotiate customized bilateral contracts in over-the-counter 
markets. Do you agree that market participants should have the 
broadest possible range of standardized and customized options 
for managing their financial risk and is there a danger that a 
one-size-fits-all attitude will harm liquidity and innovation?

A.5. The Federal Reserve supports central counterparty (CCP) 
clearing of credit default swaps and other over-the-counter 
(OTC) derivatives because, if properly designed and managed, 
CCPs can reduce risks to market participants and to the 
financial system. Counterparties to OTC derivatives trades 
sometimes seek to customize the terms of trades to meet very 
specific risk management needs. These trades may not be 
amenable to clearing because, for example, the CCP could have 
difficulty liquidating the positions in the event a clearing 
member defaulted. A requirement to clear all OTC derivative 
trades thus offers the uncomfortable alternatives of asking 
CCPs to accept business lines with difficult-to-manage risks or 
of asking customers to accept terms that do not meet their 
risk-management needs. A hybrid system in which standardized 
OTC derivative contracts are centrally cleared and in which 
more customized contracts are executed and managed on a 
bilateral, decentralized basis is a means for allowing product 
innovation while mitigating systemic risks. The Federal Reserve 
recognizes, however, that a key part of this strategy is 
improvements in the risk management practices for OTC 
derivatives by the financial institutions that are the 
counterparties to bilateral trades.

Q.6. What is the impact of the final UDAP rule issued last 
December on consumers and businesses who use ``no interest'' 
financing? I understand the impact to be very large and I would 
appreciate the Federal Reserve Board working to clarify that 
``no interest'' financing can be used in the future albeit 
perhaps with revised disclosures and marketing.

A.6. In the final rule addressing unfair and deceptive credit 
card practices, the Board, the Office of Thrift Supervision 
(OTS), and the National Credit Union Administration (NCUA) 
(collectively, the Agencies) expressed concern regarding 
deferred interest programs that are marketed as ``no interest'' 
but charge the consumer interest if purchases made under the 
program are not paid in full by a specified date or if the 
consumer violates the account terms prior to that date (which 
could include a ``hair trigger'' violation such as paying one 
day late). In particular, the Agencies noted that, although 
these programs provide substantial benefits to consumers who 
pay the purchases in full prior to the specified date, the ``no 
interest'' marketing claims may cause other consumers to be 
unfairly surprised by the increase in the cost of those 
purchases. Accordingly, the Agencies concluded that prohibiting 
deferred interest programs as they are currently marketed and 
structured would improve transparency and enable consumers to 
make more informed decisions regarding the cost of using 
credit.
    The Agencies specifically stated, however, that the final 
rule permits institutions to offer promotional programs that 
provide similar benefits to consumers but do not raise concerns 
about unfair surprise, For example, the Agencies noted that an 
institution could offer a program where interest is assessed on 
purchases at a disclosed rate for a period of time but the 
interest charged is waived or refunded if the principal is paid 
in full by the end of that period.
    The Board understands that the distinction in the final 
rule between ``deferred interest'' and ``waived or refunded 
interest'' has caused confusion regarding how institutions 
should structure these types of promotional programs where the 
consumer will not be obligated to pay interest that accrues on 
purchases if those purchases are paid in full by a specified 
date. For this reason, the Board is consulting with the OTS and 
NCUA regarding the need to clarify that the focus of the final 
rule is not on the technical aspects of these promotional 
programs (such as whether interest is deferred or waived) but 
instead on whether the programs are disclosed and structured in 
a way that consumers will not be unfairly surprised by the cost 
of using the programs. The Agencies are also considering 
whether clarification is needed regarding how existing deferred 
interest plans should be treated as of the final rule's July 1, 
2010, effective date. If the Agencies determine that 
clarifications to the final rule are necessary, those changes 
will assist institutions in understanding and complying with 
the new rules and should not reduce protections for consumers.








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