[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
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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
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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
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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.
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\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
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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.
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\2\ The Web site is located at http://www.federalreserve.gov/
monetarypolicy/bst.htm
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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.
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\1\ Policy Statement on Financial Market Developments by the
President's Working Group on Financial Markets, March 13, 2008.
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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.