[Senate Hearing 111-206]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-206


                     NOMINATION OF BEN S. BERNANKE

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

                                HEARING

                               before the

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

                     ONE HUNDRED ELEVENTH CONGRESS

                             FIRST SESSION

                                   ON

THE NOMINATION OF BEN S. BERNANKE, OF NEW JERSEY, TO BE CHAIRMAN OF THE 
            BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

                               __________

                            DECEMBER 3, 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          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 KAY BAILEY HUTCHISON, Texas
MARK R. WARNER, Virginia             JUDD GREGG, New Hampshire
JEFF MERKLEY, Oregon
MICHAEL F. BENNET, Colorado

                    Edward Silverman, Staff Director

              William D. Duhnke, Republican Staff Director
                     Marc Jarsulic, Chief Economist
                       Amy Friend, Chief Counsel
                   Julie Chon, Senior Policy Adviser
                  Joe Hepp, Professional Staff Member
                   Lisa Frumin, Legislative Assistant
                     Dean Shahinian, Senior Counsel
               Mark F. Oesterle, Republican Chief Counsel
                 Jeff Wrase, Republican Chief Economist
                       Dawn Ratliff, Chief Clerk
                      Devin Hartley, Hearing Clerk
                      Shelvin Simmons, IT Director
                          Jim Crowell, Editor

                                  (ii)










                            C O N T E N T S

                              ----------                              


                       THURSDAY, DECEMBER 3, 2009

                                                                   Page

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

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     4
    Senator Johnson
        Prepared statement.......................................    76

                                NOMINEE

Ben S. Bernanke, of New Jersey, to be Chairman of the Board of 
  Governors of the Federal Reserve System........................     6
    Prepared statement...........................................    76
    Biographical sketch of nominee...............................    79
    Responses to written questions of:
        Senator Shelby...........................................    92
        Senator Johnson..........................................    93
        Senator Bayh.............................................    94
        Senator Menendez.........................................    95
        Senator Merkley..........................................    98
        Senator Bunning..........................................   105
        Senator Vitter...........................................   140

              Additional Material Supplied for the Record

Letter submitted by Senator Shelby...............................   157

                                 (iii)

 
                     NOMINATION OF BEN S. BERNANKE,
                     OF NEW JERSEY, TO BE CHAIRMAN
                    OF THE BOARD OF GOVERNORS OF THE
                         FEDERAL RESERVE SYSTEM

                              ----------                              


                       THURSDAY, DECEMBER 3, 2009

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:02 a.m., in room SD-106, Dirksen 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. The Committee will come to order. We are 
here this morning to consider the nomination of Ben Bernanke to 
be the Chairman of the Federal Reserve.
    Mr. Chairman, let me begin by welcoming you once again to 
the Senate Banking Committee. You have been before us on 
numerous occasions over the last couple of years, and we 
welcome your participation, and we want to thank you for 
joining us again here today.
    Today we are faced with, as I see it, two separate 
questions--and before I begin, let me just say, for the 
purposes of Members' information, we are going to have a series 
of votes on the floor of the Senate. My intention would be to 
go until about 11:45, the next hour and 45 minutes, adjourning 
at 11:45, and then coming back at 1 p.m., because we will have 
these series of votes, Mr. Chairman, and rather than having it 
sort of be disjointed going back and forth, we will have it in 
two parts. And we will get as much done as we can.
    When it comes time, I am going to have just opening 
statements by Senator Shelby and me, and then we will hear the 
statement by the Chairman, and then I am going to have 8 
minutes to 10 minutes for questions. What I will do is put the 
yellow light on at 8, and, again, I have never been rigid about 
banging a gavel down, but I would ask Members to try and keep 
their questions in that timeframe so we can get to as many of 
our colleagues as possible and limit, to the extent possible, 
this afternoon.
    Obviously, if you want a second round, we will do that as 
well. I do not want to deprive any Members of the opportunity 
to be heard. But that is the way in which we will proceed.
    So, again, today we are faced, as I see it with this 
nomination, with actually two separate questions. First, should 
Ben Bernanke here, our nominee, stay on as the Chairman of the 
Federal Reserve? And, second, as this Committee works to create 
a financial regulatory structure for the 21st century, what 
should be the role of the institution that our Chairman here, 
the nominee, would oversee? Does the existing structure of the 
Federal Reserve deserve to be maintained? Too often that 
question has been dominated by the personality of the Fed 
Chairman. But in my view, this is not about the nominee or the 
Chairman, nor is it about the Members of this Committee, 
including the Chairman of this Committee. This is about the 
institution that will be around long after the nominee or the 
Members of this Committee are gone. What makes the most sense 
for the success of this institution, the Federal Reserve?
    So first let me address the nomination for another term as 
Chairman of the Federal Reserve. This is an incredibly 
important job during a crucial time in our Nation's history, as 
we all know. Over the last year, our Nation has been rocked by 
a devastating economic crisis. This Committee has met dozens of 
times to talk about its impact on our constituents, the 
millions of Americans who have lost their jobs, families who 
have lost their homes, and those who have watched their wealth 
evaporate as home values dropped and investments were wiped 
out.
    Under your leadership, Mr. Chairman, the Federal Reserve 
has taken extraordinary actions to right the economy, providing 
liquidity to depositories, sustaining the commercial paper 
market, working with the United States Treasury to restart the 
asset-backed securities market, and providing very critical 
support to the housing market. These efforts have played, in my 
view, a very significant role in arresting the financial 
crisis, and financial markets have begun to recover.
    For that, Mr. Chairman, you and the Federal Reserve 
deserve, in my view, praise for your acumen and gratitude for 
the role in preventing a far worse outcome than we might have 
otherwise seen. And I believe that you deserve another term as 
Chairman of the Federal Reserve, and I intend to vote for your 
nomination, both in this Committee and on the floor of the U.S. 
Senate, because I believe that you are the right leader for 
this moment in our Nation's economic history, and I believe 
your reappointment sends the right signal to markets.
    And while I congratulate you for these efforts, I remain 
very concerned, as you know, about the weaknesses in the 
overall financial regulatory system that allowed the financial 
collapse to occur in the very first place, which brings me to 
the second question.
    Does the structure of the institution you will oversee 
deserve to be maintained as it presently is constituted? Today 
we have a regulatory structure, as I see it, created by 
historic accidents as Government reacted to problems with 
piecemeal solutions over nearly a century. You and I, I think, 
agree that the Federal Reserve should be strong and very, very 
independent--and I feel very strongly about that second word--
and be able to perform its core functions: conducting monetary 
policy, supervising payment systems, and acting as the lender 
of last resort.
    I worry that over the years loading up the Federal Reserve 
with too many piecemeal responsibilities has left important 
duties without proper attention and exposed the Fed to 
dangerous politicization that threatens the very independence 
of this institution.
    Congress gave the Federal Reserve the authority to protect 
consumers in mortgage markets in 1994. We have talked about 
this many, many times in this Committee. But for many years, 
many of us in the Senate were frustrated in our efforts to get 
the Fed to address predatory lending, and the Federal Reserve 
failed to develop meaningful mortgage guidelines and 
regulations until the housing bubble burst.
    There have been other lapses in consumer protections with 
the Fed doing little, in my view, over the years to protect 
users of credit cards and checking accounts from abusive 
company practices.
    In addition, in my view, the Fed failed to rein in 
excessive risk taking by some of the largest holding companies 
which it supervised. Many of the firms whose irresponsible 
actions contributed to the crisis and ultimately required a 
taxpayer-funded bailout did so under the Fed's watch.
    The lesson I believe we can learn from these mistakes is 
that the country is best served by a strong, focused central 
bank, not one that is saddled with too many diverse missions 
and competing responsibilities, that its independence and 
competency--when its independence and competency are called 
into question.
    It has been proposed that the Fed assume yet another role 
in controlling threats to overall financial stability. But I 
fear these additional responsibilities would further distract 
from the Fed's core mission and leave it open to dangerous 
politicization, undermining its critical independence.
    And so as Congress takes up the financial reform this year, 
I have proposed creating new entities outside the Federal 
Reserve to focus responsibilities for bank regulation, consumer 
protections, and systemic risk so these important duties will 
not need to compete for the Federal Reserve's attention. 
Appreciating that conducting effective monetary policy requires 
full access to information on banks, my proposal, our proposal, 
preserves and expands the Fed's involvement and ability to 
access information directly from financial institutions and the 
new bank regulators, the ability to participate in bank exams, 
new authority to regulate systemically important payment and 
financial utilities, and a seat on the boards of the bank 
regulator, the systemic risk agency.
    What I am proposing does not exclude the Fed from 
involvement in these issues but, rather, expands the 
participants in this effort. We share the goal of a strong, 
focused, independent Federal Reserve that can operate 
successfully as part of a new regulatory framework that will 
restore our Nation's economic security, and I look forward to 
working with you on this very important task.
    I know there are many important issues that my colleagues, 
of course, want to discuss here today with you as they consider 
your nomination. Again, I think you are deserving of 
renomination and confirmation by the U.S. Senate. I believe you 
have done a very good job in helping us avoid the kind of 
catastrophe that could have occurred in this country. But I 
also believe we bear responsibility to consider the institution 
which you lead beyond the role of our tenure, either as Chair 
of this Committee or Chair of the Federal Reserve, and that is 
why I raise these issues as part of an overall reform of the 
financial regulatory structure that has been the desire of many 
people over many, many years. And in the absence of the 
situation we find ourselves in today, I suspect we would not be 
dealing with it.
    So, again, I welcome your participation here today, 
congratulate you on the work you have done, and let me turn to 
Senator Shelby for any opening comments. Then we will hear from 
you and proceed with questions.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Chairman Dodd. Welcome, Mr. 
Chairman.
    We all know Chairman Bernanke's academic accomplishments 
prior to joining the Board of Governors, first as a member and 
then as its Chairman. He was and remains one of our Nation's 
leading scholars on the Great Depression. I believe that his 
expertise in this area has served him well during our current 
crisis.
    It is important to note, however, that every crisis has a 
beginning, a middle, and an end. And while we learned a great 
deal about crisis management from the Great Depression, it 
appears that we have learned precious little about how to avoid 
the situation in the first place.
    Prior to the recent financial crisis, the Federal Reserve 
kept interest rates, I believe, far too low for too long, 
encouraging a housing bubble and excessive risk taking. In 
addition, the Fed failed to use its available powers to 
mitigate those risks.
    Congress also bears some responsibility. Often over my 
objections here, we enacted housing policies that imprudently 
encouraged homeownership to levels we now know were 
unsustainable. We also failed to curtail the activities of the 
housing GSEs--Fannie Mae and Freddie Mac. My record on that 
topic I think is well known here.
    After the recession that ended in 2001, which was preceded 
by the bursting of the dotcom bubble, the Fed was concerned 
about a sluggish economy and the specter of deflation. Given 
those concerns, the Fed chose to hold interest rates remarkably 
low for years. Indeed, the effective Federal funds rate was 
well below 2 percent between 2001 and November of 2004.
    During most of that period, now-Chairman Bernanke served as 
a member of the Board of Governors of the Federal Reserve and 
supported the low interest rate policies. In 2002, then-
Governor Bernanke warned of deflation. He stated, and I will 
quote,

        . . . the Fed should take most seriously . . . its 
        responsibility to ensure financial stability in the economy. 
        Irving Fisher (1933) was perhaps the first economist to 
        emphasize the potential connections between violent financial 
        crises, which lead to ``fire sales'' of assets and falling 
        asset prices, with general declines in aggregate demand and the 
        price level. A healthy, well-capitalized banking system and 
        smoothly functioning capital markets are an important line of 
        defense against deflationary shocks. I believe the Fed should 
        and does use its regulatory and supervisory powers to ensure 
        that the financial system will remain resilient if financial 
        conditions change rapidly.

    The Governor's warning was clear. Deflation is a potential 
danger which could ignite a financial crisis. The policy 
prescriptions seem equally clear: keep interest rates low, 
liquidity flows high, and lean against deflation pressures. 
However, while keeping interest rates low for a protracted 
period of time, the Fed appeared remarkably unconcerned about 
the possibility of igniting a financial crisis by inflating the 
housing price bubble, which, ironically, led to the same 
result: a violent financial crisis and a fire sale of assets.
    As housing prices soared and risk taking escalated, Wall 
Street investors pressed on as if a ``Fed put'' was assured. 
The notion was that in adverse market conditions, the Fed would 
absorb faltering assets and flood the markets with liquidity. 
Indeed, Governor Bernanke at that time assured markets that the 
Fed stood ready to use the discount window and other tools to 
protect the financial system, a reassurance that the ``Fed 
put'' was in place.
    In 2004 and 2005, Chairman Bernanke and other members of 
the Board of Governors spoke of the possibility of a great 
moderation involving potential permanent reduction in 
macroeconomic volatility and risk, no doubt a result of 
vigilant and adept monetary policy.
    In retrospect, this misperception left market participants 
believing that large risks had been mitigated, opening the door 
for greater risk taking. In the face of rising home prices and 
risky mortgage underwriting, the Fed failed to act. The Fed 
chose not to use its rulemaking authority over mortgages to 
arrest risky lending and underwriting practices. And although 
numerous statutes such as TILA, HOEPA, the Equal Credit 
Opportunity Act, the Real Estate Settlement Procedures Act--
RESPA--and the Home Mortgage Disclosure Act gave the Fed the 
authority to act, nothing was done.
    The Fed also made major forecasting errors leading up to 
the recent crisis. Then after the housing market bubble began 
to burst in 2006, the Fed was slow to entertain possible 
spillovers from the housing sector into the general economy and 
the financial system. Finally, in response to the growing 
crisis, the Fed took actions that often appeared to be ad hoc 
and piecemeal.
    Many of the Fed's responses, in my view, greatly amplified 
the problem of moral hazard stemming from too-big-to-fail 
treatment of large financial institutions and their activities. 
In addition, some Fed actions were taken in concert with the 
Treasury, blurring the distinction between fiscal policy 
functions of the Congress and Treasury and the central bank's 
monetary policy and lender of last resort functions.
    Under Chairman Bernanke's watch, the Federal Reserve vastly 
expanded use of its discount window, including the provision of 
funds to some institutions over which the Fed had no oversight. 
The Fed also created new lending facilities to channel 
liquidity and credit to markets that were deemed most stressed 
and systemically important.
    Consequently, the Fed's balance sheet has ballooned from a 
pre-crisis level of around $800 billion to more than $2.2 
trillion through credit extensions and purchases of risky 
private assets, GSE debt, and U.S. Treasury debt. Many Fed 
actions were innovative ways to provide liquidity to a wide 
variety of financial institutions and market participants. Some 
actions, however, amounted to bailouts. When dealing with 
individual institutions deemed systemically important by the 
Fed, shareholders were wiped out and management replaced. 
However, in many instances, bond holders were made whole even 
though they were not legally entitled to such favorable 
treatment. Using powers granted under Section 13(3) of the 
Federal Reserve Act, the Fed made it explicit that certain 
institutions and activities would not be allowed to fail.
    Recently, certain Fed Governors have stated that private 
risk absorbed by the Fed involved only a small portion of its 
enormous asset holdings. Furthermore, some have suggested that 
the Government might even make money on some of its risky 
bills. And while some of this might be true, I do not believe 
potential profit is the appropriate metric for evaluating 
Government support of private risk. Taxpayers simply should not 
be subjected to possible losses from private risk.
    Mr. Chairman, for many years I held the Federal Reserve in 
very high regard. I had a great deal of respect for not only 
its critical role in the U.S. monetary policy, but also its 
role as a prudential regulator. I believe it to be the Nation's 
repository of financial expertise and excellence, and over the 
years we have enacted a number of laws which demonstrated our 
confidence in your institution. We trusted the Fed to execute 
those laws when deemed prudent and necessary. I fear now, 
however, that our trust and confidence were misplaced in a lot 
of instances.
    The question before us now, Mr. Chairman, is: What are we 
to do about it? Currently, the Committee is discussing, as 
Senator Dodd said, the future of our regulatory system. To the 
extent that we can identify weaknesses that contribute to the 
crisis, we should address them. But not everything that went 
wrong can be blamed on the system because the system also 
depends on the people who run it. It is those individuals who 
need to be accountable for their actions or their failure to 
act.
    Mr. Chairman, I believe in accountability. The Senate's 
constitutional authority to advise and consent can be a highly 
effective means by which this body can hold individuals 
accountable. It is a process through which we can express our 
disapproval of past deeds or our lack of confidence in future 
performance.
    We continue to face considerable challenges, including 
still stressed financial markets, rising nonperforming 
commercial real estate loans, tight credit conditions, record 
high mortgage delinquency rates, double-digit unemployment, 
hemorrhaging deficits and public debt, and concerns about the 
size of the Fed's balance sheet, the value of the dollar, and 
the possibilities of yet more bubbles.
    Certainly, we are still deep in the woods, Mr. Chairman. 
The question before us is whether Chairman Bernanke is the 
person best suited to lead us out and keep us out of trouble.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Chairman Bernanke, welcome again to the Committee.

STATEMENT OF BEN S. BERNANKE, OF NEW JERSEY, TO BE CHAIRMAN OF 
      THE BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

    Mr. Bernanke. Thank you. Chairman Dodd, Senator Shelby, and 
Members of the Committee, I thank you for the opportunity to 
appear before you today. I would also like to express my 
gratitude to President Obama for nominating me to a second term 
as Chairman of the Board of Governors of the Federal Reserve 
System and for his support for a strong and independent Federal 
Reserve. Finally, I thank my colleagues throughout the Federal 
Reserve System for the remarkable resourcefulness, dedication, 
and stamina they have demonstrated over the past 2 years under 
extremely trying conditions. They have never lost sight of the 
importance of the work of the Federal Reserve for the economic 
well-being of all Americans.
    Over the past 2 years, our Nation, indeed the world, has 
endured the most severe financial crisis since the Great 
Depression, a crisis which in turn triggered a sharp 
contraction in global economic activity. Today, most indicators 
suggest that financial markets are stabilizing and that the 
economy is emerging from the recession. Yet our task is far 
from complete. Far too many Americans are without jobs, and 
unemployment could remain high for some time even if, as we 
anticipate, moderate economic growth continues. The Federal 
Reserve remains committed to its mission to help restore 
prosperity and to stimulate job creation while preserving price 
stability. If I am confirmed, I will work to the utmost of my 
abilities in the pursuit of those objectives.
    As severe as the effects of the financial crisis have been, 
however, the outcome could have been markedly worse without the 
strong actions taken by the Congress, the Treasury Department, 
the Federal Reserve, the Federal Deposit Insurance Corporation, 
and other authorities both here and abroad. For our part, the 
Federal Reserve cut interest rates early and aggressively, 
reducing our target for the Federal funds rate to nearly zero. 
We played a central role in efforts to quell the financial 
turmoil, for example, through our joint efforts with other 
agencies and foreign authorities to avert a collapse of the 
global banking system last fall; by ensuring financial 
institutions adequate access to short-term funding when private 
funding sources dried up; and through our leadership of the 
comprehensive assessment of large U.S. banks conducted this 
past spring, an exercise that significantly increased public 
confidence in the banking system. We also created targeted 
lending programs that have helped to restart the flow of credit 
in a number of critical markets, including the commercial paper 
market and the market for securities backed by loans to 
households and small businesses. Indeed, we estimate that one 
of the targeted programs--the Term Asset-Backed Securities Loan 
Facility--has thus far helped finance 3.3 million loans to 
households--excluding credit card accounts--more than 100 
million credit card accounts, 480,000 loans to small 
businesses, and 100,000 loans to larger businesses. And our 
purchases of longer-term securities have provided support to 
private credit markets and helped to reduce longer-term 
interest rates, such as mortgage rates. Taken together, the 
Federal Reserve's actions have contributed substantially to the 
significant improvement in financial conditions and to what now 
appear to be the beginnings of a turnaround in both the U.S. 
and foreign economies.
    Having acted promptly and forcefully to confront the 
financial crisis and its economic consequences, we are also 
keenly aware that, to ensure longer-term economic stability, we 
must be prepared to withdraw the extraordinary policy support 
in a smooth and timely way as markets and the economy recover. 
We are confident that we have the necessary tools to do so. 
However, as is always the case, even when the monetary policy 
tools employed are conventional, determining the appropriate 
time and pace for the withdrawal of stimulus will require 
careful analysis and judgment. My colleagues on the Federal 
Open Market Committee and I are committed to implementing our 
exit strategy in a manner that both supports job creation and 
fosters continued price stability.
    A financial crisis of the severity we have experienced must 
prompt financial institutions and regulators alike to undertake 
unsparing self-assessments of their past performance. At the 
Federal Reserve, we have been actively engaged in identifying 
and implementing improvements in our regulation and supervision 
of financial firms. In the realm of consumer protection, during 
the past 3 years, we have comprehensively overhauled 
regulations aimed at ensuring fair treatment of mortgage 
borrowers and credit card users, among numerous other 
initiatives. To promote safety and soundness, we continue to 
work with other domestic and foreign supervisors to require 
stronger capital, liquidity, and risk management at banking 
organizations, while also taking steps to ensure that 
compensation packages do not provide incentives for excessive 
risk taking and an undue focus on short-term results. Drawing 
on our experience in leading the recent comprehensive 
assessment of 19 of the largest U.S. banks, we are expanding 
and improving our cross-firm, or horizontal, reviews of large 
institutions, which will afford us greater insight into 
industry practices and possible emerging risks. To complement 
on-site supervisory reviews, we are also creating an enhanced 
quantitative surveillance program that will make use of the 
skills not only of supervisors, but also of economists, 
specialists in financial markets, and other experts within the 
Federal Reserve. We are requiring large firms to provide 
supervisors with more detailed and timely information on risk 
positions, operating performance, and other key indicators, and 
we are strengthening consolidated supervision to better capture 
the firm-wide risks faced by complex organizations. In sum, 
heeding the lessons of the crisis, we are committed to taking a 
more proactive and comprehensive approach to oversight to 
ensure that emerging problems are identified early and met with 
prompt and effective supervisory responses.
    We also have renewed and strengthened our longstanding 
commitment to transparency and accountability. In the making of 
monetary policy, the Federal Reserve is highly transparent, 
providing detailed minutes 3 weeks after each policy meeting, 
quarterly economic projections, regular testimonies to the 
Congress, and much other information. Our financial statements 
are public and audited by an outside accounting firm, we 
publish our balance sheet weekly, and we provide extensive 
information through monthly reports and on our Web site on all 
the temporary lending facilities developed during the crisis, 
including the collateral that we take. Further, our financial 
activities are subject to review by an independent Inspector 
General. And the Congress, through the Government 
Accountability Office, can and does audit all parts of our 
operations, except for monetary policy and related areas 
explicitly exempted by a 1978 provision passed by the Congress. 
The Congress created that exemption to protect monetary policy 
from short-term political pressures and thereby to support our 
ability to effectively pursue our mandated objectives of 
maximum employment and price stability.
    In navigating through the crisis, the Federal Reserve has 
been greatly aided by the regional structure established by the 
Congress when it created the Federal Reserve in 1913. The more 
than 270 business people, bankers, nonprofit executives, 
academics, and community, agricultural, and labor leaders who 
serve on the boards of the 12 Reserve Banks and their 24 
branches provide valuable insights into current economic and 
financial conditions that statistics alone cannot. Thus, the 
structure of the Federal Reserve ensures that our policymaking 
is informed not just by a Washington perspective or a Wall 
Street perspective, but also by a Main Street perspective.
    If confirmed, I look forward to working closely with this 
Committee and the Congress to achieve fundamental reform of our 
system of financial regulation and stronger, more effective 
supervision. It would be a tragedy if, after all the hardships 
that Americans have endured during the past 2 years, our Nation 
failed to take the steps necessary to prevent a recurrence of a 
crisis of the magnitude we have recently confronted. And as we 
move forward, we must take care that the Federal Reserve 
remains effective and independent, with the capacity to foster 
financial stability and to support a return to prosperity and 
economic opportunity in a context of price stability.
    Thank you again for the opportunity to appear before you 
today. I would be happy to respond to your questions. Thank 
you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Mr. Chairman. Again, I 
will ask the clerk to keep an eye on the clock here so we move 
along with the questions this morning.
    Let me begin, in a sense, in talking about both systemic 
risk obligations as well as the whole issue of the supervisory 
authority. You wrote your piece for The Washington Post a few 
days ago in which you raised the concern that if you lacked the 
supervisory capacity here, it would directly affect your 
ability to conduct monetary policy. And yet we have had 
witnesses before this Committee over the last number of months, 
including the former Fed Vice Chair Alice Rivlin, former Fed 
Monetary Affairs Director Vince Reinhart, and Alan Meltzer, who 
is a long-time scholar of the Fed, among others. And their 
testimony says that the Fed's bank supervisory authority plays 
very little role in the formation of monetary policy.
    Under the proposal that we have proposed and put before the 
Committee, the Fed would not be a bank supervisor, but it would 
have access, which was not necessarily reflected in your piece, 
but it would have access, as you know, to all the information 
it currently has about banks, could participate in examinations 
of any bank or bank holding company, and would be part of the 
systemic risk regulator.
    Wouldn't this information allow you to carry out the Fed's 
core functions of setting monetary policy and acting as the 
lender of last resort since it is the access to the information 
that really is critical for the conduct of monetary policy and, 
therefore, the objections to the proposal we have made here are 
really not as well founded as they might appear to be in the 
piece?
    Mr. Bernanke. Thank you Mr. Chairman. As you know, I do 
think that taking the Federal Reserve out of active bank 
supervision would be a mistake for the country. First, I think 
it should be noted that the Federal Reserve has unparalleled 
expertise that arises from its work in monetary policy. We have 
a great group of economists, financial markets experts, and 
others who are unique in Washington in their ability to address 
these issues. And as we go forward, as we try to supervise 
complex, multi-company firms, holding companies, and as we try 
to look at the system as a whole from a so-called 
macroprudential perspective, which involves looking at the 
interactions of companies and markets, we need not just bank 
supervisors who can go in and read a loan file, but also 
financial market experts and economists who can create the 
context and the supplementary analysis that will make these 
more difficult analyses possible. And we demonstrated the value 
of this in the stress tests earlier this year.
    The second argument, the one that you alluded to 
specifically, Mr. Chairman, has to do with the benefits to the 
Federal Reserve of having these supervisory authorities. You 
mentioned monetary policy. There is some benefit to monetary 
policy, and I can give instances. But I think the greater 
benefit is actually to our ability to help maintain financial 
stability and to be an effective lender of last resort.
    In the current crisis, for example, our ability to respond 
to the crisis, to address problems in the banking system, to 
help stabilize key markets was critically dependent on our 
ability to see what was going on in the banking system and to 
have the expertise inside the Federal Reserve to evaluate what 
was happening. There is no way we could have been as involved 
or effective in this crisis if we did not have that expertise 
and that information.
    If you go back into history, there are many other examples. 
Just to give one more, after 9/11, the Federal Reserve played a 
central role in restoring the financial system to operational 
capacity, and our knowledge of what was happening in the banks, 
their funding positions, their need for liquidity, the risks 
that they faced operationally and otherwise, was absolutely 
critical in our ability to do that. And there are many other 
examples.
    So I do believe that monetary policy is benefited, but 
financial stability is even more important in that the ability 
of the Fed to play its role in stabilizing the financial system 
and being lender of last resort, in addition we need to be able 
to look at collateral and understand the solvency of banks to 
make loans to banks, requires our involvement in bank 
supervision.
    My belief, and looking at other countries where now the 
trend is very much toward reversing earlier decisions to strip 
regulatory powers from central banks, the trend now is to go 
back exactly the opposite direction. In Europe and the United 
Kingdom, for example, the political discourse is leaning very 
heavily toward increasing and adding the supervisory and 
macroprudential responsibilities to the central bank, and that 
comes from an experience of the last couple of years where the 
inability to have complete information greatly hampered the 
function of those central banks in addressing the financial 
stability issues.
    Being on a board, having the ability to go along on an exam 
will never substitute for having your own expertise, your own 
information, your own ability to go in when you believe that 
there is an issue. Mr. Chairman, I understand your objectives 
here, but I do believe it is a very, very serious matter to 
take the Fed essentially out of financial stability management, 
which this I think would do.
    Chairman Dodd. Well, it is not our intention to take it 
out, at all, but rather expand the number of eyes that are 
looking at these situations so we have better judgments, 
because clearly, one of the problems occurred in the 
supervisory role of bank holding companies, of course, that was 
an abysmal failure. Now, I am talking about before your tenure.
    But nonetheless, looking at systemic risk and while we are 
examining ways to have resolution mechanisms here that will 
avoid the kind of moral hazards associated with giving the 
implicit backing of the Federal Government should an 
institution become deeply troubled, it seems to me it is in our 
interest to try to avoid that occurrence from happening, and 
the way they do that, obviously, is having the kind of 
supervisory function here that would allow a decision to be 
made where an institution was getting precariously close to 
causing systemic risk--and again, my concern is here about 
institutional issues rather than the individuals involved in 
decision making.
    But here we were at a time when we are now looking back, 
all the signs were so blatantly clear, and yet in conducting 
its supervisory capacity within the Fed, it failed terribly, 
and giving us the kind of warnings that we should have had as a 
country of where we were headed, particularly in the bank 
holding company area.
    And so my concerns about this are based on recent history 
where there has been a failure in performing that function, and 
therefore the concerns that maybe we ought to be looking at 
something different that would provide us with the greater 
warnings, the predictions, the ability to respond so you are 
not spending the last 2 years as we were.
    And I admire what you have done over the last 2 years, but 
it shouldn't have gotten to that. We never should have arrived 
at that moment. We shouldn't have had to go through what we did 
for the last 2 years had there been cops on the street doing 
their job, telling us what was going on and allowing us to 
avoid the problem in the first place.
    Why should I give an institution that failed in that 
responsibility the kind of exclusive authority we are talking 
about here?
    Mr. Bernanke. Mr. Chairman, it is true that there were 
weaknesses in that supervision, and I described in my testimony 
some of the steps we are taking to strengthen it. But the 
Federal Reserve was not the systemic regulator. It had a very 
narrowly described set of supervisory responsibilities, bank 
holding companies, primarily, as you point out. But if you look 
at the firms and the markets and the instruments that caused 
the problems, a great number of them, and Senator Shelby 
mentioned one or two, were mostly outside of the Federal 
Reserve's responsibility.
    And so there was a failure across the system, and we all 
have to do better, that is for sure. But in terms of changing 
the structure, I think what we need is not only to do a better 
job, but we need to make a structure whereby we are looking at 
the system as a whole, that we are not looking just 
individually at each individual institution. We are trying to 
look at the whole system collectively. And I believe that the 
changes that have been proposed that will create a Systemic 
Risk Council and so on would do that and would help us, 
independent of who is Chairman or who is head of the FDIC or 
the SEC, would help us have a better chance of identifying 
those system problems in advance.
    Chairman Dodd. Let me jump quickly, because time is about 
up here for me and I don't want to exceed it, and I am sure 
others will ask you about the commercial real estate. Senator 
Shelby has already raised it. And the jobs picture, which if I 
had had exclusive time with you, I just want to talk about 
where we are going with jobs.
    But let me raise the issue, because an economist by the 
name of--I may mispronounce his name--Roubini, who correctly, 
we are told, predicted the global financial crisis that we are 
now in, and many other economists are concerned that the 
world's central banks are flooding the financial institutions 
with too much cash, setting the stage for another asset bubble 
burst. I don't know if you have been familiar with his 
predictions at all or not. With interest rates near zero in the 
United States, the dollar has dropped 12 percent in the past 
year against a basket of six major currencies. According to Mr. 
Roubini, investors worldwide are borrowing dollars to buy 
assets, including equities and commodities, fueling huge 
bubbles that may spark another financial crisis.
    Quickly, can you tell us whether or not you think this 
threat has legitimacy, and if so, what we are doing about it?
    Mr. Bernanke. It is certainly something we want to pay 
close attention to, but let me distinguish between the United 
States and abroad. In the United States, of course, it is 
inherently very difficult to know if asset prices are 
appropriate or assets are correctly valued, but we have been 
trying to do our best to look at valuation models and other 
metrics and we do not see at this point any extreme mis-
valuations of assets in the United States. Of course, all that 
is contingent on your beliefs about where the economy is going 
to go. Mr. Roubini is very pessimistic about the economy, and, 
of course, if the economy were to weaken tremendously, then 
asset prices would be overvalued where they are today, but only 
in that case.
    There have been complaints about U.S. monetary policy 
contributing to bubbles abroad, and I think it needs to be 
understood that the United States monetary policy is intended 
to address both financial and economic issues in the United 
States and countries which have their own tools to address 
bubbles in their own economies, including the flexibility of 
their exchange rate, their own monetary policies, their own 
fiscal policy, their own supervisory policies. So it really is 
not the United States's responsibility to make sure that there 
are no misalignments in every economy in the world when those 
countries have their own tools to address them.
    Chairman Dodd. Well, thank you, but this is an issue we 
want to stay in close contact with you and others on this 
matter to see if this thing emerges as a growing problem as 
this economist and others are warning us.
    Senator Shelby.
    Senator Shelby. Thank you, Chairman Dodd.
    I want to stay on some of the subjects, Chairman Bernanke, 
that Senator Dodd has raised. In the past, you have argued--and 
still do--that there are certain synergies between supervision 
and regulation of financial firms and the conduct of monetary 
policy and the Fed's lender of last resort function. If we were 
to go back, Mr. Chairman, and review the minutes and 
transcripts of all FOMC meetings between 2003 and 2008, I 
wonder what fraction of the time would have been devoted to 
issues involving supervision and regulation of, say, your 
holding companies, or our holding companies. Was it half the 
time? Was it a fourth of the time? An eighth of the time? A 
tenth of the time? In other words, give us your judgment on 
that.
    Mr. Bernanke. Well, in a typical meeting, there would be 
very little discussion. Let me take that back. Recently, we 
have talked about it quite a bit because of the financial----
    Senator Shelby. Sure.
    Mr. Bernanke. ----financial crisis. But it depends on the 
situation. There are periods like recently, but also, for 
example, in the early 1990s--when the banking system faced what 
were called the financial headwinds and were holding back 
economic growth--where those issues were important and were 
discussed. Under normal circumstances, they would be discussed 
much less. That is absolutely right.
    But to reiterate what I said to Chairman Dodd, although I 
do think that the bank supervision is helpful in monetary 
policy, it provides us with information we otherwise wouldn't 
have, and there are some academic studies which show that there 
is a link between bank supervision information and Fed monetary 
policy responses, I again would put a much heavier weight on 
the financial stability function whereby in order to be a 
lender of last resort and to know how to respond to an ongoing 
crisis or threat of crisis, we need to have the expertise, 
information, and authorities associated with being a bank 
supervisor.
    Senator Shelby. Would it be fair to say that before the 
crisis in the last couple of years, that not a lot of time was 
spent on regulatory supervision----
    Mr. Bernanke. Well----
    Senator Shelby. ----talking, discussion?
    Mr. Bernanke. Let me remind you of the structure of the 
Fed. The Federal Open Market Committee is about monetary policy 
primarily, and so the general economy--inflation, unemployment, 
and so on--are the primary issues----
    Senator Shelby. It is foremost, is it not?
    Mr. Bernanke. I am sorry?
    Senator Shelby. That would be foremost what you----
    Mr. Bernanke. That would be the foremost issues in the 
FOMC. Of course, the Board of Governors, as opposed to the 
FOMC, has responsibility for overseeing the system's bank 
supervision activities, and, of course, there, that activity is 
ongoing, and particularly recently, as we worked hard to try to 
both address the crisis and to correct the problems, it has 
been a major priority for the Federal Reserve.
    Senator Shelby. Mr. Chairman, do you believe--you have been 
on the Fed for quite a while now and you have been Chairman, 
this is your fourth year--do you believe that the Federal 
Reserve, even under your tenure, not your predecessor's, before 
the crisis hit, when you first went there, the first year or 
two, was doing more than an adequate job of supervising and 
regulating the holding companies which subsequently got in such 
trouble, not just Citicorp, but a lot of them, and that was all 
under your watch at the Fed as a regulator?
    Mr. Bernanke. Well, again, as I said before, there are 
failures all through the system. We heard this morning the Bank 
of America is paying back its TARP----
    Senator Shelby. Good news.
    Mr. Bernanke. ----that is good news----
    Senator Shelby. When are they going to pay it back?
    Mr. Bernanke. Immediately.
    Senator Shelby. Any day?
    Mr. Bernanke. In its entirety, immediately.
    Senator Shelby. OK.
    Mr. Bernanke. So as we go through the bank holding 
companies, as I said, we ran a stress test through the bank 
holding companies in the spring, and of the 19, I think it was 
nine were declared to be in good health and they paid back 
their TARP and then the rest have all raised capital. So those 
firms, in some sense, have not been the crux of the crisis. The 
real problems have been mostly outside of the bank holding 
companies.
    Senator Shelby. Let us go back just to your tenure, 2005, 
2006, early 2007. Where was the Fed as a regulator to try to 
prevent the crisis? Do you believe that the Federal Reserve 
knew what was going on with, say, the holding companies, and if 
so, why the debacle if they really knew? They either knew or 
they didn't know. A lot of people believe--Senator Dodd alluded 
to this--that the Fed has done a horrible job as a regulator, 
and now yet you are wanting to continue as a regulator, which 
is only part of your real job----
    Mr. Bernanke. Well, Senator, it was an extraordinary crisis 
which has tested every single regulator, both here and abroad. 
Did we do everything we could? Absolutely not. I talked in my 
testimony about things we were doing to improve.
    I think the question that lies before you, if you fight a 
battle and you lose the battle, does that mean you never use an 
army again? You have to improve and fix the situation. You 
don't have to necessarily eliminate the institution.
    So I think that we did certainly not a perfect job, by any 
means, but I don't think we stand out as having done a worse 
job than other regulators. And again, many of the critical 
firms and markets that were the worst problems were outside of 
our purview.
    Senator Shelby. Do you believe that a bank should have a 
role or a say in any way of who their regulator might be, such 
as the Reserve banks?
    Mr. Bernanke. No, I don't, and in the----
    Senator Shelby. Do you believe that 13 Act should be 
changed?
    Mr. Bernanke. Well, of course, the Congress created that 
structure, but----
    Senator Shelby. Absolutely.
    Mr. Bernanke. ----but the way it actually functions is that 
there is no connection--the Reserve banks--the banks who are 
members of the boards of the 12 Reserve banks select--vote 
for----
    Senator Shelby. Explain to the audience and the Committee 
again how the members of the Reserve banks, say the Federal 
Reserve of Atlanta, Richmond, New York, San Francisco----
    Mr. Bernanke. I would be glad to do that----
    Senator Shelby. Tell them how they are selected on the 
Board.
    Mr. Bernanke. OK. So----
    Senator Shelby. Who does the nomination?
    Mr. Bernanke. Yes, sir. So again, as provided by the 
Federal Reserve Act, each of the 12 Reserve banks has a Board 
of Directors with a chairman. The directors, 12 at each bank, 
are in three classes. One class is drawn from banks in the 
district. Most of them are community banks. The second class, 
so-called B class, are people who are technically elected by 
the banks. And the C class is supposed to represent the general 
public.
    Senator Shelby. Elected by the banks who they supervise, 
right?
    Mr. Bernanke. But let me describe how the process actually 
works. The way the process actually works is that, first, the 
directors are chosen for the most part by the leadership of the 
Reserve bank. They are nominated by the leadership of the 
Reserve bank in order to be a wide representative cross-section 
of economic and community leaders in the district. So, for 
example, among the 70 or so B and C directors, there are three 
from financial services. There are many more from 
manufacturing, wholesale, retail trade, agriculture, all 
different kinds of areas. They are not bankers. Then, moreover, 
both the directors and the Reserve bank president must be 
approved by the Board of Governors in Washington.
    Senator Shelby. But, Mr. Chairman, we understand that. But 
do you believe that anybody that is going to be supervised by a 
banking regulator should have a say-so in choosing that 
regulator? It seems to me and others it is an inherent conflict 
of interest and an incestuous financial relationship that is 
not good for the Federal Reserve. It is not good for banks. It 
shows conflicts of interest to me.
    Mr. Bernanke. Well, I can see why in terms of the way the 
law is written, you might think that, but the way it has 
actually been structured, the way it actually operates is that 
the boards of directors are drawn in practice from a wide 
cross-section of the public and I should add, that there are 
very strong firewalls. They have no ability to influence or 
even be informed about supervisory policy.
    Senator Shelby. I know my time is up, but last, do you 
believe that the Federal Reserve Bank, say the Federal Reserve 
of New York and Richmond, San Francisco, and so forth, that 
they basically are the regulator and that you, as the Chairman 
of the Board of Governors, have outsourced that to the Reserve 
banks?
    Mr. Bernanke. Absolutely not.
    Senator Shelby. Why haven't you?
    Mr. Bernanke. The Board of Governors has the legal 
authority and responsibility to manage that supervision. They 
function as operational arms of the Board of Governors, but we 
set the policy, we do the quality control, we do the reviews, 
we set the budgets. So your earlier criticism, to the extent 
you are correct, the buck stops here, we are responsible for 
that and we are, if anything, continuing to strengthen, 
centralize, and continuing to work to make sure that that 
supervision is as strong as possible.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    Senator Johnson.
    Senator Johnson. Welcome to the Committee, Chairman 
Bernanke. I want to join Chairman Dodd in voicing support for 
your confirmation. While I certainly think that transparency is 
important, it is the Fed's independence and its ability to 
carry out day-to-day decisions about monetary policy without 
intrusion of Congress that strengthens the Fed's credibility 
and allows it to follow policies that maximize price stability 
and economic stability.
    What do you think about current proposals being considered 
by Congress to audit the Fed's monetary policy decisions and to 
change the way that boards of regional Fed Reserve banks are 
chosen by making them political appointees? If agreed to, how 
would these proposals change the way the Fed operates?
    Mr. Bernanke. Senator, first of all, thank you for the 
question. I think there is, at least among the public, some 
misunderstanding of the word ``audit.'' Audit sounds like a 
financial term. I believe that the Congress should have all the 
information it needs about the Federal Reserve's financial 
operations, its financial controls, to have appropriate 
oversight of our use of taxpayer money. We are, in fact, very 
transparent about our financial operations and I have listed 
some of the things in my testimony that we provide, including 
an audited balance sheet, regular reports, and the like.
    In addition, the GAO has the authority to audit every 
aspect of the Federal Reserve except for monetary policy and 
related functions, as provided for by an exemption passed by 
the Congress in 1978. And the GAO is, in fact, actively engaged 
in looking at supervision and many other aspects. We have 
currently 14 engagements with the GAO, including looking at our 
consolidated supervision and some of the things that Senator 
Shelby referred to.
    So to be very, very clear, I in fact I welcome transparency 
about the Fed's activities and the Fed's financial position, 
both to the public and to the Congress. I am, however, 
concerned with the auditing of monetary policy. What that means 
is that the GAO would be empowered to come in essentially 
immediately after a policy decision to look at all the policy 
materials prepared by staff, to interview members, and to 
basically second-guess the Fed's decision in very short order 
with very few protections.
    My concern is that, as you mentioned, Senator, the Fed's 
credibility depends on the market's perception that we are 
independent in making monetary policy decisions and we will not 
be influenced by short-term political considerations. My fear 
is that if we were to take what might be perceived as an 
unpopular step, that Congress would order an audit, which would 
be a way, essentially, of applying pressure, or be perceived as 
a way of providing pressure to our policy decisions.
    And so I would ask the Congress to consider retaining the 
1978 exemption, which is a very wise exemption. It allows full 
access to our financial operations and controls and access to 
almost all of our policy activities, but gives the appropriate 
distance to monetary policy to maintain the independence and 
credibility of that policy.
    Senator Johnson. I am very concerned that if banks aren't 
lending to small business, we will not be able to create the 
jobs we need to decrease our Nation's unemployment. What is the 
Fed doing to encourage banks that lend to small businesses that 
are ready to hire?
    Mr. Bernanke. Senator, first of all, I very much agree with 
you. I talked about this in a speech in New York a couple of 
weeks ago. Many of the credit markets are functioning much 
better and larger firms are pretty well able to get access to 
credit, as Bank of America showed overnight. But firms that are 
dependent on banks, like small businesses, are having much more 
difficulty. And since small businesses are such a major source 
of job creation, particularly in an upswing like we are hoping 
will continue from here, their being constrained by lack of 
access to credit has direct implications for employment growth 
and it is very significant.
    The Fed has been very much engaged in trying to improve 
credit access for small businesses. We have provided guidance 
to banks which emphasizes that it is very important that they 
not be so over-conservative, that they not make loans to 
creditworthy borrowers, including small businesses. And we have 
backed up that guidance with, first, training programs for our 
examiners to make sure that they understand the importance of 
taking a balanced perspective, that while we want banks to be 
very careful and prudent, we don't want them to fail to make 
loans to creditworthy borrowers, such as small businesses.
    We recently put out guidance which is relevant here to 
banks on how to manage commercial real estate. This is relevant 
because many small businesses borrow against their premises, 
against real estate collateral. In that guidance, we showed in 
quite a bit of detail how examiners and banks should work 
together to make sure that there is not undue pressure put on 
banks not to make loans, that good loans are not marked down 
inappropriately, that loans that can pay off even if the 
collateral value has declined can still be made. And so a small 
business that uses its store or its place of business as 
collateral can still get credit.
    So we continue to work with the banks. We have urged them 
to raise capital, as you know. As I mentioned, the stress test 
led to an enormous amount of capital raising by the banks, 
which will over time improve their ability to lend, as well. 
And even more directly, we have been working to increase the 
flow of funds from investors to small businesses, primarily 
through our TALF program, which has been trying to restart the 
securitization markets. That TALF program, as I mentioned in my 
testimony, has greatly improved the ability for SBA loans to be 
securitized and sold to investors and has led to extension of 
hundreds of thousands of small business loans. In addition, we 
are also helping to securitize commercial mortgage-backed 
securities, which again help small businesses to the extent 
that it frees up the commercial real estate financing situation 
and allows them to borrow against their place of business, for 
example.
    Senator Johnson. There has been much discussion about the 
effectiveness of the economic stimulus package that was enacted 
in February to create and save jobs. In your judgment, is the 
stimulus package creating jobs and vindicating some of the 
effects of the economic crisis? Are there additional fiscal 
policy responses that Congress can take to help the current 
economic situation?
    Mr. Bernanke. Senator, I think it should first be noted 
that only about 30 percent of the funds that were authorized 
last February have been disbursed, and probably something less 
than that have actually been spent. And so in some sense, it is 
still rather early to make a judgment.
    The judgment is also made more difficult by the fact that 
you have to ask the question, where would we be without this 
package? What would the counterfactual be? And that, of course, 
requires models and analysis which reasonable people can 
disagree about. So I think it is a little bit early to make a 
strong judgment, a little bit early to decide whether or not to 
do additional fiscal actions. But we will continue to analyze 
it and try to estimate the effects on the economy.
    Senator Johnson. Mr. Chairman, I yield back.
    Chairman Dodd. Thank you very much.
    Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman.
    Welcome, Chairman Bernanke. I am not going to go down the 
same road as many of my colleagues because I think that ground 
is going to be pretty well plowed, to mix two metaphors here.
    [Laughter.]
    Senator Bennett. So I am going to discuss something I think 
somewhat different, and let me set the stage for it. We all 
talk about the Great Depression. I was born during the Great 
Depression, but I have no memory of it. But I was running a 
business during the Great Inflation and I have a very clear 
memory it. And the speed with which the Great Inflation 
disappeared from our economy has somewhat removed the pain, but 
my memory is still very strong.
    In the Carter years, and one of your predecessors had to 
deal with that, Mr. Volcker, I remember going to a bank and 
begging, and that is the operative word, for a loan to allow me 
to meet payroll after having maxed out my credit card, because 
I was the CEO of that company, and being absolutely delighted 
when the banker finally gave it to me at 21 percent interest. 
Mr. Volcker, with some assist--let the historians work out who 
gets most of the credit--from President Reagan ultimately broke 
the back of the Great Inflation and set the stage for a long 
period of economic growth that came after that.
    We are now looking ahead in a circumstance that many 
economists say are laying the groundwork for the next Great 
Inflation. Let me quote from Bob Samuelson's column this 
morning. He says this week's White House Jobs Summit will try 
to revive economic growth, but it will be a hard slog. Job 
creation is fundamentally a private sector process and the 
private economy is experiencing a broad retreat from credit-
driven spending.
    Mark Zandi of Moody's reports this astonishing figure. 
Since last spring, the number of bank credit cards has dropped 
100 million, about 25 percent. Banks are tightening credit 
standards, partly in reaction to new credit card legislation 
designed to protect borrowers from rate increases, and 
consumers are canceling cards.
    Meanwhile, empty office buildings, shuttered retail stores, 
and underutilized factories have depressed business investment 
spending. In the third quarter, it was down 20 percent from its 
2008 peak. Despite huge Federal budget deficits, total 
borrowing in the economy dropped in the first half of this 
year. This hasn't happened in statistics since 1952.
    Then he goes on, in the short run--and this will take me 
where I am going--Zandi doesn't worry about the effects on the 
Federal budget deficit because borrowing by consumers and 
companies is so weak. But the perception that the 
administration will tolerate, despite rhetoric to the contrary, 
permanently large deficits could ultimately rattle investors 
and lead to large, self-defeating increases in interest rates. 
There are risks in over-aggressive government job creation 
programs that can be sustained only by borrowing or taxes.
    All right. As I look at the projections we are getting out 
of the administration, they are saying that the deficits are 
going to run at 4.2 percent of GDP as far as the eye can see, 
and I don't see the economy growing any faster than, say, 2 
percent, at least in the foreseeable future. And that, to me, 
is a recipe for the Japanese disease, where this economy 
becomes like the Japanese economy and ultimately for major 
inflation.
    Now, if we confirm you, that is going to be on your plate, 
maybe not in the next six to 12 months, but certainly during 
your 4-year term. Is inflation going to come back? And if it 
comes back because of these massive Federal deficits to which 
Samuelson refers, how are you going to deal with it and what do 
you see in your crystal ball?
    Mr. Bernanke. Thank you, Senator. Let me just first say 
that in terms of your reminiscences about the 1970s, I remember 
those periods, too, although I wasn't a businessman at the 
time, and inflation is very corrosive. It is very bad for the 
economy. And I just want to reiterate that the Fed has a strong 
commitment to price stability and we will maintain that 
commitment. In particular--you didn't ask about this, and I 
won't go into detail--we are thinking a great deal about our 
exit strategy from our current monetary policy actions, 
including the size of our balance sheet and our special 
programs.
    I can't help but just take the opportunity to--your 
reference to Chairman Volcker. Nineteen-seventy-eight was when 
the Congress passed the law that made monetary policy 
independent of GAO audits. Subsequently, the support of 
President Carter and President Reagan for Chairman Volcker to 
let him do what he had to do, was the reason that inflation was 
conquered and it did set the stage for many years of 
prosperity. Again, it is just a case study of why Federal 
Reserve policy independence is so critical.
    With respect to deficits, and though I agree very much that 
we cannot continue to have deficits that make our debt relative 
to our GDP rise indefinitely, we need to come down, deficits 
that are closer to 2 to 3 percent at most, not 4 or 5 percent. 
If we do that in the medium term, we can begin to stabilize the 
amount of debt growth to GDP. It is----
    Senator Bennett. Let me interrupt you----
    Mr. Bernanke. Sure.
    Senator Bennett. ----to make this point.
    Mr. Bernanke. Yes.
    Senator Bennett. I am an appropriator, which is maybe not a 
good thing to be in this election year, but I am an 
appropriator. The Appropriations Committee has influence over 
one-third of the Federal budget. The other two-thirds is on 
automatic pilot in mandatory spending for entitlement programs. 
We are discussing on the floor of the Senate the creation of 
another major entitlement program, and the percentage that we 
have any control over keeps going down. Further, of the one-
third, half is the defense budget. So in terms of discretionary 
spending on domestic--well, not entirely domestic, this 
includes all our embassies overseas, the National Parks, 
education, transportation, everything else--is roughly one-
sixth of the Federal budget.
    So as you are commenting on, gee, we need some fiscal 
discipline, the trajectory is entirely in the other way as 
mandatory spending takes over. And I think you are going to be 
looking at a situation where the Congress will be unable to 
provide any kind of fiscal discipline because of the mandatory 
spending. This year, Federal revenue is projected at $2.2 
trillion. Mandatory spending at $2.2 trillion. Every single 
thing we spend money on in the government other than mandatory 
spending, we have had to borrow every single dime, and I don't 
see that structural circumstance changing. I see it going in 
the other direction, and that puts an enormous burden on your 
plate.
    Mr. Bernanke. Well, Senator, I was about to address 
entitlements. I think you cannot tackle this problem in the 
medium term without doing something about getting entitlements 
under control, reducing the costs particularly of health care. 
It is only mandatory until Congress says it is not mandatory, 
and we have no option but to address those costs at some point, 
or else we will have an unsustainable situation.
    As far as the Fed is concerned, we will not monetize the 
debt. We will maintain price stability. But we would not be 
able to do anything about interest rates going up if creditors 
began to lose confidence in the U.S. Fiscal sustainability. 
This is obvious, but I think it is worth saying, and you are 
right to raise it, that we need not only an exit strategy from 
monetary policy; we very much need an exit strategy from fiscal 
policy in the sense we need to get back to--we need to have a 
plan, a program to get back to a sustainable fiscal trajectory 
in the next few years.
    Senator Bennett. If I may, Mr. Chairman, very quickly, when 
you say the Fed will not monetize it, that means that if my son 
starts a business in a few years, he is going to be paying 21-
percent interest rates as well?
    Mr. Bernanke. No, sir, not if the 21 percent comes from 
inflation, which is where a lot of that came from in the 1970s. 
We are not going to support inflation, but we might not be able 
to stop rises in real interest rates even given a stable price 
level.
    Senator Bennett. Thank you.
    Chairman Dodd. Thank you very much, Senator.
    Senator Reed.
    Senator Reed. Welcome, Mr. Chairman. Was the trajectory of 
Federal spending and Federal Reserve policy more appropriate at 
the end of 2000 or the end of 1999 than it is today?
    Mr. Bernanke. Well, we have certainly faced a lot more 
challenges since then.
    Senator Reed. I seem to recall we had a surplus.
    Mr. Bernanke. We did have a surplus.
    Senator Reed. And we had unemployment rates that were about 
4.6 percent. We had economic growth and income growth across 
the spectrum at every level. So what happened?
    Mr. Bernanke. Well, going back to some of the themes that 
Senator Shelby raised, the stock market boom was not 
sustainable. It popped, and that contributed to the recession 
of 2001. And now, of course, we have had a financial crisis and 
a deep recession, which has dragged down tax revenues and 
created needs for supporting people out of work and other 
important objectives.
    So a lot of what is happening right now, of course, these 
enormous deficits we have this year and next year are not 
permanent. They are reflecting the current situation. But some 
of it will be permanent unless we begin to address particularly 
the entitlement issue and the aging issue.
    Senator Reed. So you would concur that our effort today to 
pass health care reform is critical to our economic future.
    Mr. Bernanke. I am not going to comment on the overall 
health care bill. What I will just say is that I think an 
essential element would be to try to reform health care in a 
way that controls costs going out, and that is going to be 
essential.
    Senator Reed. And that is what the CBO has concluded in 
their evaluation of the Senate plan before us. Is that correct?
    Mr. Bernanke. They have talked about some premiums. I do 
not think they have made a strong statement about the share of 
GDP devoted to health care, for example.
    Senator Reed. They have indicated that going forward there 
would be cost savings. I think from my view, the faster we get 
this accomplished, then we can move on to some of the other 
issues we have talked about today.
    I recall in the 1990s, because I was here, that there was 
only really two ways you can deflect this deficit, and that is 
either by cutting expenditures or raising income taxes or other 
forms of taxes. Can you think of another way?
    Mr. Bernanke. To reduce deficits?
    Senator Reed. Yes.
    Mr. Bernanke. Well, just logically, there are other kinds 
of taxes besides income taxes.
    Senator Reed. No, no. I concede that. Some type of tax.
    Mr. Bernanke. And on the spending side, again, you know, 
Willie Sutton robbed banks because that is where the money is, 
as he put it. The money in this case is in entitlements. Those 
are the programs which are growing. At the rate we are going, 
in about 15 years the entire Federal budget will be 
entitlements and interest, and there will not be any money left 
over for defense or any of the other activities.
    So, clearly, we are facing a very difficult structural 
problem in that we have an aging society and rising health care 
costs, and the Government has very substantial obligations. I 
am not in any way advocating unfair treatment of the elderly 
who have worked all their lives and certainly deserve our 
support and help. But if there are ways to restructure or 
strengthen these programs that reduce costs, I think that is 
extraordinarily important for us to try to achieve.
    Senator Reed. Would you take taxes off the table?
    Mr. Bernanke. I would not do anything. Those decisions are 
up to Congress.
    Senator Reed. Well, your predecessor signaled very strongly 
that the tax cuts in 2000 were appropriate.
    Mr. Bernanke. I have not done that. I have done my best to 
leave that authority where it belongs--with the Congress.
    Senator Reed. One of the most pressing issues that we face 
across the country is employment, frankly, and you have made 
the point that you will begin to reduce the stimulus, the aid 
that the Fed is providing at some point. That will be done, I 
hope, with the recognition that until we restore employment 
across the country, we have not brought back the economy. We 
have not restored confidence in the economy, and we have not 
made it productive for the working people of this country. Is 
that your view?
    Mr. Bernanke. Yes. I think jobs are the issue right now, 
and I think it is not just today's incomes, today's production. 
It is also about the future. We have a situation where 30 
percent of African American young people are unemployed, very 
high fractions of young people in general. People who begin 
their work careers without a job, obviously, are going to be 
losing opportunities to gain on-the-job training, to learn 
skills, and it will affect them for many years down the road.
    So there are very severe, long-lasting costs associated 
with unemployment rates at the level we are seeing and with the 
duration of unemployment we are seeing, and it really is the 
biggest challenge, the most difficult problem that we face 
right now.
    Senator Reed. What do we do about it? I mean, I do not want 
to be glib, but there are both fiscal and monetary 
consequences, and what we have seen, particularly in the last 
several months, is that the actions of the Federal Reserve 
together with fiscal actions, are effective, we hope, in some 
cases. So what would you propose to do about the employment 
situation?
    Mr. Bernanke. Well, on the Federal Reserve side, we have 
continued to keep interest rates close to zero to try to 
stimulate growth, and we have seen now positive growth in 
output, which will translate into jobs, we are hoping soon.
    I think a very important issue is credit. If there is not 
credit, then that affects the ability of people to buy autos 
and other goods and services. It affects the ability of small 
businesses to hire and maintain their inventories. So I have 
discussed earlier some of the steps we are taking to try to 
unfreeze credit, including pushing banks to give creditworthy 
borrowers access to loans, have banks raise capital, try to 
restart securitization markets and other steps. So the Fed has 
a program we are employing which is focused on getting jobs 
created.
    Now, on the fiscal side, obviously there are a whole number 
of different options. Christina Romer had an op-ed in The Wall 
Street Journal--I think it was yesterday--where she listed some 
of the things that the administration is thinking about. 
Obviously, all of these issues will have fiscal consequences, 
and, again, the Congress will have to make those trade-offs.
    Senator Reed. Let me get to an issue that is under your 
control, that is, your supervisory responsibility with some of 
the largest financial institutions in the country, and some of 
the data I have seen suggest that local community banks are 
much more aggressive in terms of lending through the Small 
Business Administration, in lending to those small companies 
that are creating jobs, at least maintaining jobs. And if you 
look at the bigger financial institutions, they are not doing 
enough. Can you, through your supervisory responsibilities, get 
them to perform better, frankly?
    Mr. Bernanke. Well, first, on the small banks, that is not 
uniform. But it is true that, for the most part, the small 
banks did not engage in some of the activities that got the big 
banks into trouble. They do have commercial real estate issues, 
many small banks do. But it is also true that in many cases 
where large banks have withdrawn or reduced their lending, 
small banks have stepped up and have provided credit, 
particularly to small business, and that is one of the reasons 
why community banks are such a valuable part of our banking 
system.
    We face a dilemma, which is we want banks to lend, and we 
are encouraging them to lend, but we certainly do not want them 
to make bad loans because, of course, that is what got us in 
trouble in the first place. And so as I described earlier, we 
are pushing banks to make loans to creditworthy borrowers. We 
are making sure our examiners are appropriately balancing the 
needs of the borrowers in the economy against avoiding 
excessive risk aversion. We are pushing banks to raise capital, 
as the Bank of America example shows, and we have done quite a 
bit to restore the securitization market, which is very 
important in the United States. That is about a third of our 
credit system, and that was mostly shut down during the crisis, 
except for the Government-guaranteed mortgage markets. And our 
activities both in small business lending and also in 
commercial real estate have gotten those markets to look like 
they are in better shape and starting to function, and that is 
very important because it provides a source of funding for the 
banks that they can then pass on into loans.
    Senator Reed. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you. Just 30 seconds, Jim, before I 
turn to you. The Bank of America you mentioned to Senator 
Shelby and just again referenced here. Are you supportive of 
their decision to pay off these TARP monies? And do you see any 
negative implications of them doing so?
    Mr. Bernanke. We as their supervisor, along with OCC and 
others, evaluated their situation, and we felt that it was safe 
and reasonable and appropriate for them to pay off the TARP, 
and we signed off on that.
    Chairman Dodd. Thank you very much.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    Four years ago, when you came before the Senate for 
confirmation to be Chairman of the Federal Reserve, I was the 
only Senator to vote against you. In fact, I was the only 
Senator to even raise serious concerns about you. I opposed you 
because I knew you would continue the legacy of Alan Greenspan, 
and I was right. But I did not know how right I would be and 
could not imagine how wrong you would be in the following 4 
years.
    The Greenspan legacy on monetary policy was breaking from 
the Taylor rule to provide easy money and, thus, inflation 
bubbles. Not only did you continue that policy when you think 
control of the Fed, but you supported every Greenspan rate 
decision when you were on the Fed earlier this decade. 
Sometimes you even wanted to go farther to provide easier money 
than Chairman Greenspan.
    As recently as a letter you sent me 2 weeks ago, you still 
refuse to admit Fed action played any role in inflating the 
housing bubble despite the overwhelming evidence and the 
consensus of economists to the contrary. And in your effort to 
keep filling the punch bowl, you cranked up the printing 
presses to buy mortgage securities, Treasury securities, 
commercial paper, and other assets from Wall Street.
    Those purchases, by the way, led to some nice profits for 
the Wall Street banks and dealers who sold them to you, and the 
GSE purchases seemed to be illegal since the Federal Reserve 
Act allows only the purchase of securities backed by the 
Government.
    On consumer protection, the Greenspan policy was, ``Do not 
do it.'' You went along with his policy before you were 
Chairman, and you continued it after you were promoted. The 
most glaring example is it took you 2 years to finally regulate 
subprime mortgages after Chairman Greenspan did nothing for 12 
years. Even then you only acted after pressure from Congress 
and after it was clear subprime mortgages were at the heart of 
the economic meltdown.
    On other consumer protection issues, you only acted as the 
time approached for your renomination to be Fed Chairman. Alan 
Greenspan refused to look for bubbles or to try to do anything 
other than to create them. Likewise, it is clear from your 
statements over the last 4 years that you failed to spot the 
housing bubble, despite many warnings.
    Chairman Greenspan's attitude toward regulating banks was 
much like his attitude toward consumer protection. Instead of 
close supervision of the biggest and most dangerous banks, he 
ignored the growing balance sheets and increasing risk. You did 
no better. In fact, under your watch, every one of the major 
banks failed or would have failed if you had not bailed them 
out.
    On derivatives, Chairman Greenspan and other Clinton 
administration officials attacked Brooksley Born when she dared 
to raise concerns about the growing risk. They succeeded in 
changing the law to prevent her or anyone else from effectively 
regulating derivatives.
    After taking over the Fed, you did not see any need for 
more substantial regulation of derivatives until it was clear 
that they were headed into the financial meltdown thanks in 
part to those products.
    The Greenspan policy on transparency was talk a lot, use 
plenty of numbers, but say nothing. Things were so bad, one TV 
network even tried to guess his thoughts by looking at the 
briefcase he carried to work.
    You promised Congress more transparency when you came to 
the job. You promised more transparency when you came begging 
for TARP. To be fair, you have published more information than 
before, but those efforts are inadequate, and you still refuse 
to provide details on the Fed's bailout last year on all the 
toxic waste that you have bought. And Chairman Greenspan sold 
the Fed's independence to State through the so-called Greenspan 
put. Whenever Wall Street needed a boost, Alan was there.
    But you went even farther than that when you bowed to 
political pressure of the Bush and Obama administrations and 
turned the Fed into an arm of the Treasury. Under your watch, 
the Bernanke put became a bailout for all large financial 
institutions, including many foreign banks, and you put the 
printing presses into overdrive to fund the Government spending 
and hand out cheap money to your masters on Wall Street, which 
they used to rake in record profits while ordinary Americans 
and small businesses cannot even get loans for their everyday 
needs.
    Now I want to read a quote to you, Mr. Greens--Mr. 
Bernanke.
    [Laughter.]
    Senator Bunning. That is a Freudian slip, believe me.
    Here is the quote:

        I believe that the tools available to the banking agencies, 
        including the ability to require adequate capital and an 
        effective banking receivership process, are sufficient to allow 
        the agencies to minimize the systemic risks associated with 
        large banks. Moreover, the agencies have made clear that no 
        bank is too big too fail, so that bank management, 
        shareholders, and uninsured debt holders understand that they 
        will not escape the consequences of excessive risk taking. In 
        short, although vigilance is necessary, I believe the systemic 
        risk inherent in the banking system is well managed and well 
        controlled.

    That should sound familiar to you since it was part of your 
response to a question I asked about the systemic risk of large 
financial institutions at your last confirmation hearing. I am 
going to ask that the full question and answer be included in 
today's hearing record.

        Q.8. The Fed has been on the record with their fears of Fannie 
        Mae and Freddie Mac being systemic risks to our financial 
        system. Are you worried about other large financial 
        institutions with portfolios similar to the GSE's being 
        systemic risks?

        A.8. Market discipline is typically the governing mechanism 
        that constrains leverage and ensures that firms do not 
        undertake excessive risks. The market system generally relies 
        on the vigilance of creditors and investors in financial 
        transactions to assure themselves of their counterparties' 
        current condition and the soundness of their risk management 
        practices.

        Because of the availability of deposit insurance, market 
        discipline is not by itself sufficient to control risk-taking 
        in the banking system; for this reason, the Federal Reserve and 
        the other banking agencies supervise and regulate banks. I 
        believe that the tools available to the banking agencies, 
        including the ability to require adequate capital and an 
        effective bank receivership process are sufficient to allow the 
        agencies to minimize the systemic risks associated with large 
        banks. Moreover, the agencies have made clear that no bank is 
        too-big-too-fail, so that bank management, shareholders, and 
        uninsured debtholders understand that they will not escape the 
        consequences of excessive risk-taking. In short, although 
        vigilance is necessary, I believe the systemic risk inherent in 
        the banking system is well-managed and well-controlled.

        In the case of the GSE's, market discipline is problematic. 
        Market participants recognize that the GSE's are closely tied 
        to the Federal Government and such ties create a view among 
        market participants that the GSE's are implicitly backed by the 
        Federal Government, thereby weakening market discipline. 
        Consequently, strong regulatory authority and controls on GSE 
        risk-taking are needed to ensure that they do not create 
        systemic risks. Unfortunately, the GSE regulator's constrained 
        capital authority, the ineffective receivership process, and 
        other limitations weaken regulatory oversight of GSE's. Capping 
        the size of GSE portfolios, which beyond a certain size do not 
        contribute to the GSEs' housing mission, is also important for 
        controlling potential systemic risk.

    Senator Bunning. Now, if that statement was true and you 
had acted according to it, I might be supporting your 
nomination today. But since then, you have decided that just 
about every large bank, investment bank, insurance company, and 
even some industrial companies are too big to fail. Rather than 
making management, shareholders, and debt holders feel the 
consequences of their risk taking, you bailed them out. In 
short, you are the definition of a moral hazard.
    Instead of taking that money and lending it to consumers 
and cleaning up their balance sheets, the banks started to 
pocket record profits and pay out billions of dollars in 
bonuses to their management. Because you bowed to pressure from 
the banks and refused to resolve them or force them to clean up 
their balance sheets and clean up the management, you have 
created zombie banks that are only enriching their traders and 
executives. You are repeating the same mistakes of Japan in the 
1990s on a much larger scale while sowing the seeds for the 
next bubble.
    In the same letter where you refused to admit any 
responsibility for inflating the housing bubble, you also 
admitted you do not have an exit strategy for all the money you 
have printed and the securities you have bought. That sounds to 
me like you intent to keep propping up the banks for as long as 
they want.
    Even if that were not true--and I am a little over my time, 
but this is very important--the AIG bailout alone is reason 
enough to send you back to Princeton. First, you told us AIG 
and its creditors had to be bailed out because they posed a 
systemic risk, largely because of the credit default swap 
portfolio. Those credit default swaps, by the way, are over-
the-counter derivatives that the Fed did not want regulated.
    Well, according to the TARP Inspector General, it turns out 
the Fed was not concerned about the financial conditions of the 
credit default swap partners when you decided to pay them off 
at par--not at a discount, but at 100 percent. In fact, the 
Inspector General makes it clear that no serious efforts were 
made to get the partners to take haircuts, and one bank offered 
to take a haircut and you declined it. I can only think of two 
possible reasons you would not make then-New York Fed President 
Geithner try to save the taxpayers some money by seriously 
negotiating or at least taking up UBS on their offer of a 
haircut.
    Sadly, those two reasons are incompetence or a desire to 
secretly funnel more money to a select few firms, notably 
Goldman Sachs, Merrill Lynch, and a handful of large European 
banks. I cannot understand why you did not seek European 
governments' contribution to this bailout of their banking 
system.
    From monetary policy to regulation, consumer protection, 
transparency, and independence, your time as Fed Chairman has 
been a failure. You state time and again during the housing 
bubble that there was no bubble. After the bubble burst, you 
repeatedly claimed the fallout would be small, and you clearly 
did not support the systemic risk that you claimed the Fed was 
supposed to be looking out for.
    Where I come from, we punish failure, not reward it. That 
is certainly the way it was when I played baseball, and it is 
the way across all America presently. Judging by the current 
Treasury Secretary, some may think Washington does reward 
failure, but that should not be the case.
    I will do everything I can to stop your nomination and drag 
out this process as long as I can. We must put an end to your 
and the Fed's failure, and there is no better time than now. 
Your Fed has become the creature from Jekyll Island.
    Thank you.
    Chairman Dodd. Would you care to respond to that?
    [Laughter.]
    Mr. Bernanke. Let me just correct one point.
    First, I think there was some misunderstanding or 
misinterpretation of the SIGTARP's report, but we absolutely 
believed that AIG's failure would be an enormous systemic risk 
and would have imposed enormous damage not just on the 
financial system--and this is the key point--but on the entire 
U.S. economy and on every American. It is not reasonable to 
talk about letting large firms fail as if that would have no 
effect on credit extension and on the broader economy. The 
Lehman example should be enough for everybody.
    With respect to the counterparties, there is a long 
discussion there which I will not go into, but I will just 
point out one issue you raised. UBS offered a 2-percent 
discount if and only if all the other counterparties would 
accept one. That was not the case. We did our best to get a 
reduction there, but given that AIG was not bankrupt and given 
that we were not going to abuse our supervisory power, we 
really had no way to create a substantial discount.
    Senator Bunning. Mr. Chairman, may I? I do not want to take 
any more time, but the fact of the matter is AIG was 80 percent 
owned at that time by the Federal Government.
    Chairman Dodd. I want to just say--and then I am going to 
quickly turn to others, let me say I disagree with my friend 
and colleague from Kentucky about the conclusion of what ought 
to happen to your nomination. But I got to tell you, Mr. 
Chairman, I mean, going through that period at that time when 
all the headlines were about the $168 million in bonuses that 
went out to AIG and virtually no reporting whatsoever on the 
counterparty issue, and the fact of the matter that we allowed 
100 cents on the dollar to go out to the counterparties with 
little or no negotiation just is--I have raised the issue with 
others before. I do not understand that at all, and most 
Americans do not. That was billions of dollars. One company 
alone was $12.5 billion. And it is just hard to accept the 
notion that we could not negotiate with the counterparties at 
that time.
    Mr. Bernanke. We had no leverage. If we did not pay off, 
they would say, ``You are bankrupt,'' and that would----
    Chairman Dodd. We wrote a check for $180 billion to AIG. If 
we had not done that, they would have been in trouble.
    Mr. Bernanke. To AIG, but not----
    Chairman Dodd. The counterparties would have been in 
trouble, too.
    Mr. Bernanke. Well, that is all true, but most----
    Chairman Dodd. A good deal----
    Mr. Bernanke. Most of the firms were foreign. We had no 
authority or leverage over them.
    Chairman Dodd. You are the Chairman of the Federal Reserve. 
You have got power.
    Mr. Bernanke. I do not abuse my supervisory power.
    Chairman Dodd. Apparently not in that case.
    Senator Bayh.
    Senator Bayh. Well, where to begin?
    I am struck by the fact that Senator Bunning and Senator 
Sanders find themselves in agreement on this question, perhaps 
proving the old adage that ideology may be circular rather than 
linear.
    Some of us, however, Mr. Chairman, find ourselves--and I 
associate myself with the position of Chairman Dodd--in a 
different position on the question of your nomination. I will 
support you, not because I think you did not make mistakes--as 
you have admitted here today, you did--not because I do not 
think we should hold everyone accountable for doing better--I 
think we should--but because I think you are in the best place 
to improve the situation, to maximize the chances that we do 
not have a recurrence of some of these things, including the 
AIG situation that Senator Dodd mentioned.
    You know, there is a lot of culpability to go around. The 
Fed made mistakes, as you have indicated. The Treasury made 
mistakes. Virtually every other regulatory body made mistakes. 
Congress made mistakes. Those on the left made mistakes. Those 
on the right made mistakes. Virtually every other government 
and their institutions made mistakes. Virtually every 
institution of any magnitude in the private sector made 
mistakes.
    So should there be accountability? Absolutely. Do we need 
to maintain a sense of urgency to change those things that led 
to those mistakes? You bet. But some degree of modesty and 
introspection I think is in order, and perhaps even a good long 
look in the mirror, before engaging in too much Monday morning 
quarterbacking. Clairvoyance is an attribute in short supply 
around here, all the way around.
    So my question to you is: With the benefit of hindsight, 
what would you have done differently?
    Mr. Bernanke. Well, there are two areas. Senator Dodd has 
alluded to both of them. First, I think--and Senator Bunning--
we were slow on some aspects of consumer protection. Senator 
Bunning was not exactly correct. We did have nontraditional 
mortgage guidance and subprime guidance out very early in my 
term, and it took a year to do the HOEPA rules, and that is why 
it took until 2008 for those to come out. But I think that is 
an area where, if we had been more proactive--we, the Federal 
Reserve, had been more proactive--it would have been helpful, 
because I believe--again, responding to Senator Bunning--that 
it was not monetary policy so much as problems in the mortgage 
market that led to the housing boom and bust.
    Second, while, again, as you kindly put it, there were 
mistakes made all around, including other regulators, the 
private sector, Congress, and so on, in the area where we had 
responsibility in the bank holding companies, we should have 
done more. We should have required more capital, more 
liquidity. We should have required tougher risk management 
controls.
    You talked about clairvoyance. I did not anticipate a 
crisis of this magnitude and this severity. But given that it 
happened, many of the banks--but not all of them, certainly, 
but at least some of them--were not adequately prepared in 
terms of their reserves, in terms of their liquidity. That is a 
mistake we will not make again, and I advocate not only 
strengthening regulation and strengthening supervision, but 
restructuring the nature of our financial regulatory system in 
a way that it will provide a more holistic macroprudential 
approach so that we are not reliant on each individual 
regulator in their own narrow sphere, that we have some broad 
interaction among regulators that allows us to assess problems 
that are arising in the system as a whole.
    Senator Bayh. I know you are concerned about the 
independence of the Fed and perhaps the risk that there could 
be some politicization, for lack of a better term, of some of 
the functions that you perform if we do not institute the 
appropriate reforms going forward. My own view is that the last 
thing that we want is the political branches of Government 
getting, you know, more involved in setting these policies on a 
day-to-day basis, and yet at the same time we have to have 
accountability and we have to have oversight.
    What is it about some of the proposals that have been made 
that you believe go too far in the direction of oversight that 
run the risk of politicizing the functions of the Fed?
    Mr. Bernanke. Well, first, I would draw a distinction 
between our supervisory functions and so on and our monetary 
policy functions. As a supervisor, we have exactly the same 
status as every other supervisor, which is that Congress 
controls the regulatory environment. It controls the 
objectives. It is responsible for ensuring accountability. And 
the independence is at the level of making individual decisions 
about individual institutions and so on where you don't want 
politics there. But there, we don't claim any special exemption 
or protection beyond what any supervisor or, in fact, any 
regulatory agency would use.
    Senator Bayh. You are overseen and just as accountable as 
anybody else----
    Mr. Bernanke. Exactly.
    Senator Bayh. ----for those----
    Mr. Bernanke. Exactly. On monetary policy, there is 
something of a special case, which is that monetary policy by 
its very nature has to look ahead over a longer period of time, 
whereas political necessities sometimes push for a shorter 
horizon. And so there is a very, very strong finding--one of 
the major contributors is Larry Summers--I am sure you know him 
in other contexts--which shows that countries that have 
independent central banks, that make monetary policy without 
political intervention, have lower inflation, lower interest 
rates, and better performance than those in which the central 
bank is subject to considerable political control.
    Now, the Federal Reserve is a very transparent central bank 
with respect to monetary policy. We are, for example, the only 
major central bank to my knowledge that provides detailed 
minutes of each meeting 3 weeks after the meeting. We provide 
extensive quarterly projections, a monetary policy report twice 
a year, testimonies, all kinds of information which gives 
Congress and the public all the opportunities that would 
reasonably be needed to evaluate what we are doing and to 
second guess us, as always happens.
    What I am concerned about is a set of policies that would 
create the right of Congress essentially to send in 
investigators whenever a monetary policy decision potentially 
went against their short-term preferences, and I believe that 
the signal that would send to the markets and to the public is 
that Congress is no longer respecting that zone of independence 
and is making its will known and intends to influence and to 
effect short-term monetary policy decisions, which would not be 
constructive and again is very inconsistent with what we have 
learned about central banking around the world in the last 20, 
25 years.
    Senator Bayh. It might have the ironic consequence of 
making interest rates higher----
    Mr. Bernanke. Absolutely.
    Senator Bayh. ----because there would be an additional 
element of risk in the marketplace.
    My final question, Mr. Chairman, has to deal with your 
testimony regarding your role in both setting monetary policy 
and as the occasional lender of last resort and the importance 
of having not just theoretical models, but some empirical 
evidence and understanding about what is going on in the 
marketplace in terms of performing those two functions.
    My concern would be that the Fed would become, if we just 
completely removed that authority, it becomes sort of an 
isolated entity completely divorced from an understanding of 
how your decisions were playing out in the real world. So my 
question to you would be twofold. Number one, how would you 
preform a function of lender of last resort if you didn't have 
some insight into the goings on in these institutions that you 
were being asked to perhaps support, number one. How would that 
be possible? Number two, how important is some empirical data, 
a hands-on understanding of what is going on in the financial 
sector? How important is that to maximizing the chances you get 
monetary policy right?
    Mr. Bernanke. Well, on the discount window lending, I guess 
if we didn't have any examination authority, we would have to 
rely on the good will of other supervisors. I think we much 
prefer to have our own information and our own knowledge of 
what is happening in those banks. More significantly, in 
periods of crisis or stress, as the Fed uses its lender of last 
resort authority to try to stabilize a troubled financial 
system, in order to do that accurately and effectively, we need 
to know what the funding positions are of individual banks, 
what is going on in those markets, what the solvency position 
is.
    I gave the example of 9/11, when the Fed opened up its 
discount window to provide liquidity to help the financial 
system begin to function again. We could not have done that 
effectively without the information we got on the ground from 
our supervisors in the banks. The 1987 stock market crash is 
another example where our information from the banking system 
helped us to address potential threats to the integrity of the 
clearinghouses that cleared futures contracts.
    Recently, an example of this kind of problem in the U.K., 
over the past few years, the Government of Britain removed from 
the Bank of England most of its supervisory authorities and 
invested them in the Financial Supervisory Authority, the FSA. 
But when the crisis hit, and, for example, when Northern Rock 
Bank came under stress, the Bank of England was completely in 
the dark and was unable to address effectively what turned into 
a very disruptive run and a problem for the British economy.
    So currently, the trend in the U.K. and elsewhere is quite 
the opposite to take away those authorities. It is to give the 
central bank the information and authorities it needs to know 
what is going on in the banking system.
    Now, Senator Shelby asked me about the role in monetary 
policy and I would say that the role in monetary policy is 
there. It is more unusual. It doesn't happen all the time. But 
for financial stability maintenance, I think it is very, very 
important that the Fed have that kind of information and 
insight into the banking system.
    Senator Bayh. Thank you, Mr. Chairman.
    Chairman Dodd. Let me just quickly, before I turn, on both 
of those points, Mr. Chairman, I say respectfully, if we looked 
over in the G20, more than half of our colleagues in the G20 
separate supervisory and monetary policy. In fact, the 
countries that have weathered the storm rather well over the 
last couple of years have been countries that have separated 
both.
    The British system, the FSA was what they call the light 
touch in regulation. They didn't have deposit insurance very 
well, so you had the problem there. And frankly, they didn't 
have the information. When they set up the system, they 
basically didn't allow the central bank even to get 
information. I think both of those factors contributed more to 
what happened in Great Britain than the fact that you had a 
separation of supervisory and monetary policy.
    I say that--I mean, that is a legitimate debate and 
discussion, but I don't think it can be said with absolute 
certainty that the other was true.
    Senator Crapo.
    Senator Crapo. Thank you very much, Mr. Chairman.
    Mr. Chairman, I want to focus during my questions on how we 
should establish our financial regulatory system. As you know, 
this Committee is working on financial regulatory reform right 
now and one of the biggest concerns I have is that as we move 
forward in that, that we do not institutionalize the ``too big 
to fail'' syndrome. I, for one, believe that we have allowed 
companies that should have been resolved to continue with being 
propped up by the Federal Government or by the Fed and that 
that has led to a moral hazard that we need to deal with in our 
structuring of our system.
    You have very often said that we need a new resolution 
authority so that you and others can have the tools to deal 
with allowing large institutions to be wound down or resolved. 
And yet at the same time, I believe in your testimony you 
indicate that you believe that we need to have the ability, and 
you and others need to have the ability to provide necessary 
liquidity at times of crisis.
    There is obviously a problem there, and my question to you 
is how do we make the determination of what systemic risk is? 
And maybe to put it a different way, how do we make the 
determination of when it is that we should provide liquidity as 
opposed to when it is that we should--to sustain and maintain 
an institution as opposed to when we should wind down or 
resolve an institution?
    Mr. Bernanke. Well, Senator, first, on the liquidity 
function, that is to be very sharply distinguished from 
bailouts. The liquidity provision is short-term credit which is 
fully collateralized and which is made only to sound 
institutions and is meant only to provide a backstop when 
sources of short-term funding for whatever reason disappear. In 
the old days, when retail depositors ran on a bank, this was a 
way to prevent the collapse of a bank just because of lack of 
liquidity.
    Senator Crapo. Well, let me interrupt right there. Do you 
believe that we could structure a resolution authority and a 
systemic risk regulator in such a way that we could achieve 
that kind of assurance that liquidity efforts would be limited 
in that way?
    Mr. Bernanke. I do. I do, and I think it is very, very 
important. Let me just say, to be absolutely clear, the actions 
we took last fall to stabilize these firms were done extremely 
reluctantly and only because we had no good mechanism to allow 
them to fail without having severe consequences for the 
financial system and the broader economy. It is imperative, the 
most important thing that Congress can do is find a way to 
solve the ``too big to fail'' problem. I think that is 
absolutely essential. And the only way to do that is to find a 
way to let those firms fail.
    And I do believe that that can be done. It can be done in a 
way also that forces creditors to take losses, shareholders and 
other creditors to take losses, and done in a way that is 
sufficiently predictable that it will not cause as much 
disruption as the problems that we had last year. So I do 
believe it is possible and I think the model we can use is the 
model we already have for resolving failing banks, that the 
FDIC has, just applied to larger, more complex institutions.
    Senator Corker. And what type of institution would you say 
should have that authority? Would it be the Fed or would it be 
a council of regulators or would it be a new financial 
regulator that we should establish?
    Mr. Bernanke. I think the institution with the most 
experience in these kinds of resolutions is the FDIC. So I 
think the FDIC should play a significant role. The Treasury 
should probably play a significant role, as well, just to 
represent the political end of the decision making.
    The Fed is not interested in being part of this process 
except insofar as Congress views a temporary liquidity 
provision as part of the wind-down process, as being 
appropriate. But we--let me just say this as strongly as 
possible--we do not want any more AIGs. We do not want any more 
Lehman Brothers. We want a well established, well stated, 
identified, worked out system that can be used to wind down 
these companies, allow them to fail, let the creditors take 
losses, let counterparties, like the AIG counterparties, take 
losses, but without completely destabilizing the whole economy, 
as can happen.
    Senator Crapo. As a part of all of this, I am concerned 
that we will not reestablish the kinds of proper approaches and 
the principle of moral hazard until we end TARP, provide an 
exit strategy from the recent government guarantees, and decide 
how we are going to proceed with Fannie Mae and Freddie Mac. 
Wouldn't you agree with that?
    Mr. Bernanke. I do agree with that. Fannie Mae and Freddie 
Mac are particular problems and issues have to be addressed. 
But under the current situation, the TARP was used to bail out 
companies and make all creditors whole--except for the 
shareholders--under a well-designed resolution regime. Many 
creditors could--would--should lose money, which would create 
market discipline going forward, which is what is desperately 
needed to avoid the moral hazard problem that you are referring 
to.
    Senator Crapo. The recent SIGTARP quarterly report states 
that there is $317.3 billion of unobligated TARP funds 
available right now. Do you support allowing the TARP authority 
to expire on December 31, 2009?
    Mr. Bernanke. Well, I think it is very appropriate to begin 
winding it down. I think we should be clarifying what 
additional needs, if any, are still remaining to make sure that 
the financial system is still stable and will not run into any 
new problems. But I certainly think that the TARP has mostly 
served its purpose and that it is time to start thinking about 
how we are going to unwind that program. In addition, as I have 
noted several times, many banks are paying back the TARP and a 
lot of the money that was put out is now coming back to the 
Treasury.
    Senator Crapo. Do you believe that we will ultimately 
recover all the TARP dollars?
    Mr. Bernanke. I won't speak about the auto industry loans 
or those sorts of things. If you look at the money that was put 
into financial institutions specifically, I think, overall, we 
are going to end up pretty close to break even, maybe somewhat 
in the red, but not too much. And considering what was achieved 
in terms of stabilizing the U.S. financial system and avoiding 
the collapse of our system, I think that would be a good 
outcome. So I do think that, unlike some of the scare stories 
about $700 billion being thrown away, the financial 
institutions collectively will, in the end, be something close 
to a break-even there.
    Senator Crapo. Well, thank you. For my last question, I 
would like to shift to derivatives, and I appreciate the fact 
that recently you got back to me with a progress report on our 
efforts to strengthen the infrastructure for our over-the-
counter derivatives markets. In that response, you stated that 
from the perspective of end users, there will always be 
occasions when the end users' risk management needs cannot be 
met by cleared OTC products or by exchange-traded products. 
Thus, an important issue is to preserve the ability of 
counterparties to contract customized deals while properly 
managing the risk of these deals. End users have not typically 
created the large exposures to counterparties that are the 
focus of efforts to reduce systemic risk through broader 
clearing.
    The question I have is, do you believe that, again, as we 
try to structure how we are going to approach our financial 
regulatory system, that we can effectively avoid the AIG-type 
issues and the concerns that we need to deal with in that 
context from the legitimate need for end users to have the 
flexibility to hedge their unique business and risks through 
customized derivatives?
    Mr. Bernanke. I think we can. I think we do need some scope 
for customized derivatives for certain users. Those derivatives 
that can be standardized should be traded on exchanges, and I 
think that is the plan. But I would add that unlike AIG, which 
did not have significant oversight at all of their derivatives 
business, that we should be very clear that between the SEC, 
CFTC, and the bank regulators, that banks, for example, who 
create customized derivatives will also be carefully watched to 
make sure they have adequate capital and risk management for 
those positions so we don't get something like the AIG 
situation, where they had an enormous one-way bet with no 
capital behind it.
    Senator Crapo. Thank you.
    Chairman Dodd. Senator Crapo, thank you very much. Good 
questions.
    I am going to turn to Senator Schumer, and just to notify 
the Committee, there is a vote that has started, and what I 
announced earlier, we will come back at 1 p.m. rather than 
having this back-and-forth. We have got a series of votes here, 
Mr. Chairman, and I don't want to just have it be so 
disjointed. So we will go to Senator Schumer for his line of 
questioning and then the Committee will reconvene at 1 p.m.
    Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman, and thank you, 
Mr. Chairman.
    First, I want to say to you that I sat in the room with 
many others, Senator Dodd and Senator Shelby, I believe, and 
some others in this room, when we were told about the imminent 
collapse of the financial system and panic was in the air. We 
have lots of problems. This economy is not moving well enough 
from my purposes, or, I think, anybody's here, but we are not 
in the Great Depression which we might have been.
    And in a sense, you are a victim in this society when you 
solve a problem, you are better off than you avoid a problem, 
even though society is better off that the problem was avoided, 
and I think people forget how important that is. It is easy to 
criticize. It is easy to say it could have been done a 
different way. But at that moment, action was needed and needed 
quickly or we would have had financial collapse, and you did 
act quickly and I think, you know, that--well, I talked to 
Warren Buffet. He said the government deserves a high grade for 
its efforts to prevent the collapse of the financial system and 
rescue the economy from imminent free fall, and you played a 
major role there, and I hope my colleagues will remember that.
    My question is on--my first question is on something that I 
have been very critical of the Fed in the past, and that is 
consumer protection. As you know, I think the Fed dropped the 
ball on consumer protection issues. I support the creation 
Senator Dodd has proposed of a strong, independent Consumer 
Financial Protection Agency.
    Now, every day, we find a new way--banks are in trouble. We 
know that. Many of them, their profits are being squeezed here 
and there and their reaction is to raise all kinds of fees and 
recoup on the backs of consumers. There has been a new report 
that has come out on ATM fees released by BankRate.com, and 
according to that report, the average ATM fee rose 12.6 percent 
in 2009 to $2.22. That is a heck of a lot. Plus, not only will 
the bank that owns the ATM charge you, your own bank now 
probably charges you a fee for withdrawing money at ATMs owned 
by other banks. The average cost of the fee for using someone 
else's ATM is $1.32. Over 70 percent of banks charge customers 
this fee. Together with massive increases in credit card 
interest rates and other fees, like these overdraft fees that 
we are seeing, consumers are bearing a disproportionate burden 
in maintaining the health of banks' balance sheets.
    So I believe the Fed should conduct a thorough review of 
ATM fees to ensure that consumers are protected from excessive 
ATM fees, especially the double-whammy fee for using another 
bank's ATM. What is your opinion on this? You probably saw the 
study. And will the Fed agree to conduct its own study and get 
us some answers on it pretty quickly?
    Mr. Bernanke. Well, first, Senator, as you know, we have 
just put out some rules on overdraft protection in general as 
it applies to ATMs and debit cards. And it will require banks 
to get an opt-in from the consumer before they can charge them 
for an overdraft, and that will address one of those issues.
    We will definitely take a look at ATM fees and just at 
least try to verify what is happening and what the patterns are 
and we will get back to you with that information.
    Senator Schumer. Good, and could you just make some 
suggestions, at least, as to what should be done if you can't 
do them yourself?
    Mr. Bernanke. We will look at it and see what we learn.
    Senator Schumer. OK. Do you--just from your preliminary 
look at the report, do you think what is happening in ATM fees 
is similar to what is happening with credit cards and others, 
that fees are going up at a much greater rate than they did in 
the past?
    Mr. Bernanke. I would like to get back to you on the 
numbers.
    Senator Schumer. OK.
    Mr. Bernanke. I certainly find it plausible. I believe that 
the fees are going up. I think, in part, banks are trying to 
find ways to make revenue, basically----
    Senator Schumer. You bet.
    Mr. Bernanke. ----but we will look at it.
    Senator Schumer. OK. My second question relates to the next 
bubble. Senator Dodd talked about the international bubbles and 
what has happened in Dubai, but I would like to talk about the 
potential bubbles here in this country. This last crisis was a 
result of a massive bubble focused probably on real estate, and 
there has been a lot of attention lately on the Fed's zero 
interest rate policy and whether it is helping create new 
bubbles. The worry, of course, is is it going to be an instant 
replay, different actors, different script, same horrible 
outcome in terms of the horror movie we just went through.
    Raising interest rates is one answer to deal with the 
bubble, but that is obviously tricky. I would be worried about 
raising interest rates because it would hurt getting people 
back to work, which should be our number one concern. So could 
you talk a little bit about what can be done to deal with these 
potential bubbles before they burst, given that you don't have 
the tool of interest rates as easily available because of the 
difficult economic situation, and then give us a little bit of 
your thinking on whether and when interest rates should be 
raised to deal with these potential bubbles.
    Mr. Bernanke. Well, ideally, the way we should deal with 
bubbles, at least the first line of defense, ought to be 
supervision and regulation. If we have appropriate risk 
controls that force banks not to pile into overcrowded 
positions, for example, or to take excessive risks, or if we 
have a Systemic Risk Council which looks at emerging asset 
price increases or concentrations of risk across the banking 
system, I think that is the first best way to try to address 
bubbles.
    That is something, in my very first speech as a Governor in 
2002, I said. You know, the first line of defense ought to be 
regulation and supervision, and that has the benefit that it 
can help protect the system even if you are not sure that the 
increase in asset prices is a bubble or not.
    Unfortunately, we do not now have that system, and I, 
therefore, think that monetary policy has to pay some attention 
to this situation. We are looking at it. I have said in the 
past, and I continue to believe, that it is extraordinarily 
difficult to know in real time if an asset price is appropriate 
or not. But given that caveat, we are doing our best to try to 
look at the major credit and stock markets, use the valuation 
models we have, use the standard indicators that we have and 
try to look for misalignments.
    Senator Schumer. Are there any other tools other than 
interest rates that might work?
    Mr. Bernanke. In some countries, they have had special 
measures, for example, where there have been house price 
increases, there have been things like mandatory increases in 
downpayments, things of that sort. So I suppose those are ideas 
that could address specific types of problems. But for a 
general bubble, I think basically that supervision and 
regulation of the financial system is the strongest, most 
effective approach and I do not rule out using monetary policy 
as necessary if that situation does become worrisome and 
threatening to our dual mandate, which is growth and inflation.
    Senator Schumer. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator.
    I appreciate your indulgence, Chairman Bernanke, here in 
breaking this up a little bit, but I thought it maybe better 
served your interests and ours, as well, to have some 
continuity to it. So we will take a break, hope you get a bite 
to eat, and we will see you back here in about an hour.
    The Committee will stand in recess until 1 p.m.
    [Whereupon, at 12 p.m., the Committee recessed, to 
reconvene at 1 p.m., this same day.]
    Senator Johnson [presiding]. This Committee will come to 
order.
    Senator Corker.
    Senator Corker. Thank you, Mr. Chairman. I am getting my 
thoughts together. I apologize. I just came from another 
meeting.
    Mr. Chairman, thank you for being here and for your service 
and for always being available at the other end of the phone 
when questions arise. I appreciate that very much.
    I am going to spend most of my time today trying to 
understand more on a go-forward basis what needs to happen from 
a regulatory process. I know that many of us here on the 
Committee are trying to work through appropriate reg reform, 
and obviously, the Fed has been playing a big role in that.
    Let me just start with the Reg W issue. Paul Volcker 
recently has been quoted as saying, you know, that banks have 
been engaged in risky behavior. We have had people in our 
offices saying that--and if Mr. Volcker is listening, this is 
not me saying it. I am just repeating it, OK?--that he is not 
really saying the way things are, let me put it that way. And 
yet we have looked back--you know, I know Senator Warner and I 
in particular have spent a lot of time on the resolution issue, 
and the problem that occurs with the resolution and what you 
were dealing with at the time a year ago was the fact that a 
commercial bank inside a highly complex bank holding company is 
very hard to sort of take out. And yet the 23A and B 
regulations, which basically say that a bank's deposit cannot 
be used--the depositors' money cannot be used to engage in 
other things with their affiliates that might pose risk, there 
have also been some statements made that maybe you loosened 
that activity over the last year or so, couple years, and the 
fact is that bank deposits have been used more aggressively 
with affiliates than they had in the past.
    The reason it is important, it is important to know, number 
one; but it is also important as we look at resolution, if 
banks are doing this and they are highly involved with other 
entities, it is very difficult to unwind one of the 
organizations if, in fact, the bank's depositors' money has 
been used in other activities in the bank itself.
    So that is a very long-winded question. If you could give a 
fairly short answer, since I just have 8 minutes, I would 
appreciate it.
    Mr. Bernanke. I will try. The 23A exemptions allow the 
holding company--typically what happens--to put assets down 
into the bank to be financed by deposits. We do not grant those 
very often. We generally consult with the FDIC to make sure 
they are comfortable. When that is done, it is done in a way 
that makes sure the bank is not taking additional risk, that it 
is whole. So it is not, I think, a general issue. It is 
something that we have done in some of the mergers and some of 
the things that have happened, conversion to bank holding 
company status, those sorts of things. But it is not something 
that happens often. I do not think it is going to be generally 
an issue with resolution.
    There are lots of ways, though, which holding companies and 
banks are intertwined. For example, they might share an IT 
system or----
    Senator Corker. IT, right.
    Mr. Bernanke. ----risk controls or all kinds of other 
things. And in that respect, both operationally, but also in 
some ways financially, there are linkages that make it more 
complicated.
    The basic fact, which I am sure you appreciate--not 
everyone does--is that the FDIC law applies only to banks; 
whereas, a bank holding company does not have a resolution 
mechanism, and losing the bank holding company can be a very 
serious problem.
    Senator Corker. And I realize the management issue and the 
IT and, just look, I mean, the reason these organizations are 
put together is so they can work together in a more synergistic 
way. Let us face it. But should we draw a stiffer line, if you 
will, between those? And should there be any flexibility? 
Should we eliminate that so there is not either the perception 
or the substance behind the fact that some of those deposits 
may be used for more risky behavior than most people thought 
they otherwise would have been?
    Mr. Bernanke. No, I think we are in a reasonable place 
right now. Again, whenever assets are transferred down to the 
bank, there have to be guarantees, protections, backstops to 
make sure that the bank is not at risk of taking losses. And 
the purpose of those things is to segregate the bank for the 
purpose of protecting the FDIC's insurance fund, for example.
    If we go forward and have a resolution regime that 
addresses the whole company, I think these issues are still 
there, but they are less of a concern because the whole company 
will be addressed.
    Senator Corker. You have talked a great deal about there 
is--well, you have talked a great deal about the Fed 
maintaining supervision over some of the larger entities in the 
country, and some people have put theories out that, you know, 
the Fed ought to look at the--ought to supervise the top 25 
entities in America. You know, that has been a number that has 
been thrown out.
    As we look back at Citi and the fact that Citi was under 
corrective action until 2003, and then the Fed basically lifted 
that, the Fed was watching Citi--I mean, that is like Prime A, 
you know, the prime example of what the Fed is supposed to show 
prudential regulation over. And yet Citi, let us face it, 
turned out by all counts to be an absolute disaster from the 
standpoint of the activities they got involved in. It was the 
primary type of institution that the Fed should be supervising. 
And I do not say this to beat a dead horse, but it does make 
one wonder. I know a lot of people talk about the Fed being the 
adult in the room and all those kind of things, but it does 
make one wonder, you know, why that happens to be a good idea. 
And I wonder if you might expand on that.
    Mr. Bernanke. Well, there are two separate issues. The 
first is the performance of the duties and how effective a 
particular supervisor is. And I talked earlier about some of 
the things that we have done in our self-assessments, what 
mistakes we have made and problems we have found and how we are 
fixing them, and we are taking a lot of steps to try to 
strengthen our supervision and our regulation.
    But, you know, there were problems throughout the entire 
regulatory system, and if you are going to preclude anyone from 
participating in future regulation because they made mistakes 
in the crisis, you are going to be cutting about most of the--
--
    Senator Corker. We wouldn't have any regulators.
    Mr. Bernanke. You wouldn't have any regulators left. That 
is right. So, really, one question is: Can the Fed fix the 
problems? I believe we have made a lot of progress, and I would 
be happy to talk to you offline in more detail or give you a 
summary now. There is a discussion in my testimony. You know, 
we have done a lot to strengthen the regulation, increase 
capital, increase liquidity, to improve risk management 
oversight--many of the issues in the company you mentioned, but 
other companies as well.
    But then there is a second issue, which I call the 
structural issue. When you are setting up for the future a 
structure of how regulation should work, what is the role of 
the central bank? And the central bank was created to address 
financial instability, to stop panics. That followed the 1907 
panic, was what caused the Fed to be set up in the first place. 
We have the lender of last resort facility. We have the breadth 
of expertise.
    So I think, assuming that we and other regulators can 
correct the problems that we have discovered, the appropriate 
structure should be one where the Fed is involved because 
without being involved, we will not have the expertise, we will 
not have the information, we will not have the insight that 
will let us be effective in addressing systemic issues.
    Senator Corker. So I want to talk to you some more about 
that. My time is about to end. I know that you have stated you 
are going to quit buying the mortgage-backed securities that 
you are buying right now from Fannie and Freddie in March, and 
other institutions. There are a lot of people saying that when 
you do that, interest rates on home mortgages are going to go 
up a couple hundred basis points. And I think it would be 
really good for all of us to know whether you really are going 
to do that or not. I mean, I think it would be appropriate 
for--you have stated it is going to end in March. I think it 
would be appropriate for people to know so they can be making 
other plans, because I think it is going to have a huge impact 
on the market. I think a lot of people question whether that is 
within Section 14 of the Fed's charter in the first place, but 
I would love to have a response to that.
    And then, second, if we could, since my time is out and I 
am kind of filibustering, one of the things that you and I have 
talked a great deal about is just the political involvement in 
monetary policy. And I am concerned about people like us 
getting involved in monetary policy. I have stated that all the 
way through, and I think most people in this Committee would be 
very concerned about us getting involved in monetary policy.
    On the other hand, I wonder if it should go both ways, and 
what I mean by that is when the Bush administration, you know, 
touted this stimulus back in May of their last year, which most 
people saw on the surface was ridiculous--I mean, we are going 
to spread $160 billion around the country and drop it out of 
helicopters. I think most people thought it was--I will not say 
``most people.'' A lot of people thought it was a pretty silly 
idea. And yet you championed that, and that affects people here 
because the Chairman of the Fed is thought to be a really 
intelligent, important person. And, of course, you are.
    The same thing happened with this last stimulus, which in 
my opinion was absolutely not a stimulus. It is proven now it 
did not do what it was supposed to do. But, again, when you 
speak and say it ought to happen, people up here vote that way.
    So I guess I would just ask, if we are not to be involved 
in monetary policy, should you be used as a tool by whether it 
is a Republican administration or a Democratic administration 
that caused an agenda to come forth that, you know, is really a 
political agenda, not something that is necessarily good for 
our country? And, Mr. Chairman, I thank you for the generosity 
of letting me go a little longer.
    Mr. Bernanke. May I just say quickly----
    Senator Corker. Well, I would like for you more than 
quickly to answer both.
    Mr. Bernanke. Both, all right. On the mortgage-backed 
securities, we have a longstanding authorization to do that. I 
do not think there is any legal issue. We have said that the 
current program is going to come to an end at the end of the 
first quarter. It is a monetary policy decision. The Committee 
will have to see how the economy is evolving and whether or not 
we need to do more. The several hundred basis points, there is 
a lot of uncertainty about exactly what the impact will be. I 
think that is very much at the high end of what estimates are, 
but we will have to see how that plays out.
    On the fiscal part, I think you----
    Senator Corker. So people involved in home mortgages will 
just know when they know?
    Mr. Bernanke. Well, we do not know. We do not know exactly 
what the effect will be.
    Senator Corker. So saying it is going to end in March is 
just kind of like saying we are going to withdraw troops in 
Afghanistan in 18 months, just kind of saying it. I am just----
    Mr. Bernanke. Well, in order to try to mitigate the 
effects, we have been tapering it off very slowly, and so far 
we have not seen much effect, but we will see how it evolves, 
and the committee is prepared to respond, if necessary.
    On the other thing, I think you are absolutely right. As a 
general matter, I have tried to stay out of fiscal policy, and 
I do not make specific recommendations. I did not make any 
recommendations about the size or composition or any of those 
things. But you are absolutely right, and I will continue my 
practice of leaving fiscal decisions to the Congress.
    Senator Johnson. Senator Menendez.
    Senator Menendez. Well, thank you, Mr. Chairman.
    Chairman Bernanke, I just want to start for purposes of 
memory, because we often seem to have short-term memory here, 
in November of 2008 and the time--and I think you referenced it 
to some degree in your opening statement. In November of 2008, 
after those Presidential elections, you and Secretary Paulson 
came before Members of this Committee and basically said, you 
know, we have an emerging set of circumstances and we need you 
to act, to do so boldly; and in the absence of doing that, that 
we would have a global financial meltdown.
    So I want to start there because it is the beginning of 
what has then transcended since then. Is that pretty much a 
fair statement?
    Mr. Bernanke. Yes, sir, except that it was October. It was 
early October.
    Senator Menendez. October, OK. And then the actions took 
place thereof, because I often get from my constituents back in 
New Jersey, you know, ``Senator, when I make a mistake, I have 
to pay for it, and it seems when these financial institutions 
make a mistake, I have to pay for it, too.''
    And I think that the difficulty is creating the connection 
between why we acted based upon the expertise of yourself and 
others who said we needed to do so because, otherwise, there 
would be a global financial meltdown, and that obviously has 
real-life consequences to Main Street in New Jersey, or for 
that fact, across the country. Is that a fair statement?
    Mr. Bernanke. Of course.
    Senator Menendez. Now, which brings me to where we are 
today, and I want to get a sense from you: Do you believe that 
the American economy is recovering?
    Mr. Bernanke. It is beginning to grow again. We would like 
it to grow faster. We would like jobs to come back faster. But 
I do believe we avoided an even far worse situation by avoiding 
the collapse of the financial system, as you indicated.
    Senator Menendez. And to give us a sense, when we say we 
avoided--because, you know, I think Senator Bayh mentioned 
that, or maybe Senator Schumer or both, mentioned that 
sometimes when you avoid harm from happening, you get no credit 
for it. But give us a sense of what would have happened had we 
just said, you know, ``Let the markets do it on their own. Let 
them figure it out.''
    Mr. Bernanke. Well, my professional career before I came to 
the Fed was as a scholar, an academic studying financial crises 
and their effects on the economy, including the Great 
Depression. And there is a lot of evidence, not just in the 
United States but in many other countries, that when the 
financial system collapses or melts down, it has very, very 
serious effects on the broad economy. And I think just the fact 
that Lehman Brothers and the associated instability around that 
period contributed to a global recession is evidence for that 
point.
    It is my belief that if we had not acted, if Congress had 
not supported our actions to stabilize the system, if we and 
our partners in other countries had not worked together in 
those weeks in October to prevent what in my view would have 
been a collapse, a meltdown of many of the major banks in the 
world, that we could very well be in a Depression-like 
situation with much higher unemployment than today, very deep 
decline in output, and no immediate prospects for a recovery, 
unlike the situation we have today where we do see the economy 
growing.
    So I think the risks of allowing that meltdown were 
enormous, and the costs to the economy, to the taxpayer, to the 
average worker, to the average person of allowing the financial 
system to collapse--the financial system is like the nervous 
system of the economy, and if it breaks down, you get much 
broader consequences.
    So it has been a very hard message to explain, but it is 
extraordinarily important to understand that I did not 
intervene because I care about Wall Street. I am not a Wall 
Street person. I am an academic. I come from a small town. I 
did it because I knew from my studies that the collapse of the 
financial system would have extraordinarily bad consequences 
for Main Street. And that is why we did what we did, and I 
firmly believe we did the right thing.
    Senator Menendez. So now in December of 2009, I asked you 
whether the economy was recovering, and you answered, ``It is 
growing.'' Growth does not necessarily mean recovery then.
    Mr. Bernanke. Well, it is technically a recovery in that it 
is growing and that we are no longer declining, but it is 
certainly not a satisfactory situation since we have a 10-
percent unemployment rate.
    Senator Menendez. We agree on that. So what do you believe 
is the most significant threat to our economic expansion both 
in the short term and in the long term?
    Mr. Bernanke. Well, there are multiple concerns. Certainly 
one of them is that it still remains difficult to get credit, 
particularly for bank-dependent firms. That is preventing small 
businesses from hiring and from expanding.
    The high unemployment rate is a major concern because we 
are seeing not just 10-percent unemployment, but we are seeing 
very long duration of unemployment. We are seeing a lot of 
people on part-time work or on short hours, and that has 
implications not just for the short term, but for the skills 
and labor market attachment of workers going forward. It is 
going to affect people for many, many years.
    There are additional issues like our external trade 
deficit, the fiscal deficit, and so on that we do need to 
address. But in terms of the immediate recovery, as I talked 
about in a speech I gave in New York a couple of weeks ago, I 
think the two issues we need to watch most closely are the 
return, the healing of the credit system, particularly for 
smaller borrowers, and the labor market, which is, of course, 
still in great stress.
    Senator Menendez. And we seem not to have succeeded at 
dealing with the credit market in a way that meets some of our 
goals that are critical to also deal with our unemployment 
consequences.
    You know, I look at where some of the major institutions 
are getting credit. They are getting credit, you know, easily 
two points lower than some strong regional entities, and that 
is probably what is keeping them largely afloat. But the 
question is, as you do that at the Fed, where is the movement 
here--the hammer, for lack of a better--you know, to get them 
to loosen up the credit? And what can the Fed do to move it in 
a direction that also is going to begin to make a real 
significant impact on unemployment, the two things that you say 
are critical?
    Mr. Bernanke. Well, on unemployment we have a range of 
policies, including low interest rates and mortgage-backed 
securities purchases and a variety of other things.
    On credit, it is a difficult thing. I think it is a mistake 
to tell banks, ``You must lend such-and-such amount,'' because 
we got into trouble in the first place with bad loans. We want 
them to make good loans. We want to make loans to creditworthy 
borrowers. So the Fed and the other banking agencies have been 
working with the banks to try to make sure that they are not, 
either by examiners or on their own account, failing to make 
loans to creditworthy borrowers. So we have issued guidance 
about the importance of doing that. We have trained our 
examiners to look at both sides to make sure that banks are 
giving full weight to the importance of continuing 
relationships that they have with, for example, small business 
borrowers.
    We have issued guidance with detailed examples for how to 
deal with a borrower who may be making payments, but whose 
collateral, which may be his business, has declined in value, 
that it still might be important to continue lending to that 
person or to that business.
    And, in addition, we have been trying to strengthen what is 
called the shadow banking system through our program to 
increase securitization of small business loans, commercial 
real estate loans, and the like.
    So we are addressing this. We did the stress tests to get 
banks to raise capital.
    So we are working at this. We understand the critical, 
central importance of this. It is not going to be a quick 
improvement, but I do think we are seeing some improvement, and 
as the economy strengthens, there will be a mutually beneficial 
improvement in the economy and in the credit markets.
    Senator Menendez. Well, this is clearly the singular most 
important----
    Mr. Bernanke. I agree.
    Senator Menendez. I know there are many other issues that 
the Fed deals with, you know, but this is the singular most 
important issue that your chairmanship is going to be critical 
over in terms of helping us move this country forward in a way 
that its economy is recovering more robustly, that unemployment 
is being reduced, and that we give people back the dignity of 
work, which is ultimately the opportunity to sustain their 
hopes and dreams and aspirations. So I am going to be looking 
at what you are doing in that respect incredibly closely.
    Mr. Bernanke. Absolutely.
    Senator Menendez. And my time is up, but I do want to visit 
with you about the Consumer Financial Protection Agency. When 
you came to see me, we had some original conversations about 
that. But, you know, my one criticism--I think you have done a 
lot of hard work in difficult times, but my one criticism--
which really precedes your time even, but continued during your 
time--is that the Fed had broad powers in consumer financial 
protection, and it just did not use it in a timely fashion. And 
so there are many of us who question that leaving that there is 
not necessarily in the best interests of the country.
    So I will look forward to having a discussion with you on 
that.
    Mr. Bernanke. Senator, just quickly, I do not disagree with 
we were late in using those powers, but over the past 3 years 
or so under my chairmanship, we have actually been very active 
in a wide variety of areas of consumer protection.
    Senator Johnson. Senator DeMint.
    Senator DeMint. Thank you Mr. Chairman, and thank you, Mr. 
Chairman, for being here today and for your service.
    When Congress created the Federal Reserve, they created, 
arguably, the most powerful institution in the whole world. Our 
whole economy, all our prosperity, wealth, rest on the 
soundness of the dollar, as does much of the economic systems 
all around the world. So as we consider your renomination, it 
is important that we ask some difficult questions--not just of 
you, but to ourselves--because no one can say that there have 
not been major failures, and I think a lot of us have to admit 
that the Federal Government, the Federal Reserve, let down the 
American people and a lot of people have been hurt.
    I will take exception to one of the arguments that I have 
heard today and I have heard often about what we heard last 
October and what actually happened. We were told if we did not 
appropriate nearly $1 trillion to buy toxic assets, the 
worldwide economic system was likely to collapse. We 
appropriated nearly $1 trillion, and we never bought one toxic 
asset, and the world economic system did not collapse.
    Now, we can make a case and debate all we want about 
whether or not twisting banks' arms and forcing more money in 
the banking system actually helped us. We could talk about that 
all day. But the premise that we used to create this TARP 
program was never followed through on. It is difficult for me 
to find credibility in the arguments that we saved our economy.
    But I would like to ask a few questions, Mr. Chairman, and 
I would appreciate short answers. I want to cover some 
territory today. But we do not know a lot about the operation 
of the Federal Reserve, and for that reason, I think the way to 
judge performance is to look at outcomes, particularly outcomes 
based on the goals that you have set for yourself.
    In your confirmation hearing in 2005, you specifically 
listed four duties of the Federal Reserve, and I would just 
like to mention those and just ask you how you think we have 
done.
    One of them was fostering the stability of the financial 
system and containing systemic risks that may arise in the 
financial markets. Has the Federal Reserve under your 
leadership accomplished that goal?
    Mr. Bernanke. No, but we also have lots of other co-
conspirators in that problem.
    Senator DeMint. Another duty you listed, supervising and 
regulating the banking system to promote the safety and 
soundness of the Nation's banking system and financial system. 
Has the Federal Reserve under your leadership accomplished that 
goal?
    Mr. Bernanke. We found some mistakes, and we have tried to 
improve them.
    Senator DeMint. I appreciate your short answers.
    Another duty you listed was conducting the Nation's 
monetary policy in pursuit of the statutory objective of 
maximum employment. Do you feel the Federal Reserve under your 
leadership has accomplished that goal?
    Mr. Bernanke. We have moved monetary policy as much as 
possible to try to support employment growth, but, obviously, a 
10-percent unemployment rate is not very satisfactory.
    Senator DeMint. Again, I appreciate your answers.
    For me, perhaps the biggest failure in the Federal Reserve 
in the political side here in Washington is that amid all of 
these failures, the politicians, the folks in the 
administration, and Federal Reserve have claimed credit for 
saving the system while blaming capitalism and unrestrained 
free markets for our problems. That has justified the positions 
that are now being taken here in Congress in many ways to come 
back and even extend the control, the intrusion of the Federal 
Government further into the private sector. I think you have 
been a big part of orchestrating that and shifting the blame 
onto the private sector. No one is arguing that there is not 
blame to go around everywhere. But the biggest failure I have 
seen is the failure for us to recognize the role that we played 
in the lack of our oversight of Fannie Mae, who created a lot 
of these toxic assets and sold them around the world; the loose 
monetary policy that created chronically low unemployment rates 
and high leverage across the economy. But not taking some of 
the blame and making sure the public is aware of that, we have 
undermined the system that made this country prosperous, and I 
think that is an egregious error.
    I would like to just mention a few things. What you say, 
predictions you make are critically important because we act on 
them, the whole world acts on them. I would just like to 
mention a couple of these as we go along.
    On March 28, 2007, when asked about the subprime market, 
you said, and I quote, ``The impact of the broader economy on 
financial markets of the problems in the subprime market seems 
likely to be contained.''
    A little later, May 17, 2007, you said, ``We do not expect 
significant spillovers from the subprime market to the rest of 
the economy or to the financial system.''
    A little later, February 28, 2008, on the potential bank 
failures, I quote, ``Among the largest banks, the capital 
ratios remain good, and I do not expect any serious problems of 
that sort among the large internationally active banks that 
make up a very substantial part of our banking system.''
    Again, June 9, 2008, I quote, ``The risk that the economy 
has entered a substantial downturn appears to have diminished 
over the past month or so.''
    On July 16, 2008, right before our crash, speaking of 
Fannie Mae and Freddie Mac, you said, ``They are adequately 
capitalized and in no danger of failing.''
    To a large degree, the oversight that we are responsible 
for here in this Congress, we did not accomplish because of 
assurances that we had gotten over the years from your 
predecessor and from yourself. And by doing that, I think we 
have egregiously failed the American system.
    Let me mention a few things here as I run out of time. 
Capitalism depends on capital, and I would like to ask a couple 
of questions about the Federal Reserve and capital. Is the 
Federal Reserve an instrument of the Government?
    Mr. Bernanke. It is an agency of the Government, yes.
    Senator DeMint. Do you believe money is an instrument of 
Government to be manipulated as necessary to calibrate the 
collective economic behavior of the public with the perceived 
financial needs of Government?
    Mr. Bernanke. The monetary policy is intended to follow the 
mandate the Congress gave the Federal Reserve, which is to 
achieve maximum employment and price stability. That is what we 
try to achieve.
    Senator DeMint. Do you believe that employment should be a 
mission, a goal of the Federal Reserve?
    Mr. Bernanke. Yes, I think the Federal Reserve can assist 
keeping employment close to its maximum level through adroit 
policies.
    Senator DeMint. Should the Government or an agency 
established by the Government have the power to distort the 
purchasing power of money?
    Mr. Bernanke. The Federal Reserve is mandated to achieve 
price stability, and one thing you did not mention in your list 
was inflation. Inflation has been low, and in that respect, the 
purchasing power of the dollar has been good, has been stable.
    Senator DeMint. In a free market economy, you would think 
that the cost of capital would fluctuate based on supply and 
demand, yet a big part of the role of the Federal Reserve is to 
try to fix those interest rates. Is that a function that has 
been employed properly? And is that something that needs to be 
reconsidered?
    Mr. Bernanke. Well, we always need to improve our 
execution, but I think that, as evidenced by the fact that 
every major country in the world has a central bank and uses 
monetary policy, I think that is the system that we have 
determined is the most effective at this point.
    Senator DeMint. Again, I appreciate your testimony. I would 
again, as you and I have talked personally, ask you to consider 
the need to make the Federal Reserve more transparent. There is 
no reason that independence needs to mean secrecy. The 
confidence in the Federal Reserve, the mistrust around this 
country has reached new heights, and we need to do something to 
restore the faith that the American people have in their 
monetary system, their financial system, and that 
responsibility is at the Federal Reserve as well as in the 
Congress. But I would encourage you again to consider what type 
of openness or audit, as you and I have talked about, would be 
appropriate in order to reassure the American people that we 
are not looking at another Fannie Mae situation, that over 
years we were told not to worry, not to worry, everything is 
OK, and now we saw what it did. We cannot allow that to happen 
with the Federal Reserve.
    Again, Mr. Chairman, thank you very much, and I yield back.
    Mr. Bernanke. May I quickly respond to that?
    Senator DeMint. Yes, sir.
    Mr. Bernanke. Senator, on Fannie and Freddie, the Federal 
Reserve had been raising concerns about Fannie and Freddie for 
many, many years. We were on the side of concerns about that.
    In terms of transparency, I think the Congress should have 
access to all of our financial information, financial 
operations and the like, and we have made every effort to do 
that, and whatever remains to be done, we want to work with you 
to do that. Our main concern is about the independence of 
monetary policy itself and not about any financial aspect. So 
we are very much committed to transparency in all financial 
aspects of the Federal Reserve.
    Senator DeMint. Thank you, Mr. Chairman.
    Senator Johnson. Senator Akaka.
    Senator Akaka. Thank you very much, Mr. Chairman.
    Chairman Bernanke, I want to add my welcome to you and your 
family to the Committee today. I feel you have demonstrated 
tremendous skill in addressing the extraordinary economic 
crisis and challenges that we have.
    As you know, I have always greatly appreciated your 
capacity and dedicated efforts to improve the financial 
literacy of students and consumers. The true costs of financial 
illiteracy have been made all too apparent by this financial 
crisis. One of the core causes of the crisis was that families 
were steered into mortgages with risks and costs they could not 
afford or even understand, and that has been already expressed. 
We share a firm commitment to trying to better educate, 
protect, and empower consumers.
    I appreciated your advocacy and the efforts of the Federal 
Reserve to promote the use of financial institutions for lower-
cost remittances. In Hawaii, we have many families that send 
portions of their wages to family members living in the 
Philippines or other countries. Unfortunately, too often, 
consumers fail to take advantage of the lower-cost remittance 
services found at banks and credit unions.
    My question to you is, what must be done to, one, better 
inform consumers about costs associated with sending money, and 
two, to encourage mainstream financial institutions to provide 
low-cost remittances?
    Mr. Bernanke. Well, Senator, first, let me just agree with 
you wholeheartedly about financial literacy. The Federal 
Reserve has been committed to working on this for a long time, 
as you know, and, of course, the recent crisis illustrates 
abundantly how important it is that people understand the 
contracts, the financial instruments that they are taking on. 
So we will continue to work with that and we will continue to 
also try to provide consumer protections that provide the 
information, the disclosures, the protections that help people 
get into the right product, which is very important.
    I agree with you about remittances. That has been an 
interest of mine for some time. The Federal Reserve has been 
working on that. We have worked, for example, with some other 
countries to try to reduce the cost of sending money to home 
countries. But I think one of the valuable lessons here is that 
many of the remittance services that people have are quite 
expensive and they may involve costs associated with exchange 
rates and the like.
    We have encouraged institutions, where possible, to reach 
out, because if we can persuade immigrants to use mainstream 
financial institutions for remittances, they may become 
interested in having a checking account or a savings account or 
taking out a loan, if necessary. So it is a way of introducing 
people who may not be that familiar with the banking system 
into the mainstream banking system and, in many cases, reducing 
the costs that they face dealing with payday lenders and the 
like. So we do encourage that, and I think I would encourage 
financial institutions to use that tool as a way of attracting 
new customers from immigrant communities.
    Senator Akaka. Chairman Bernanke, there are too many 
unbanked individuals that lack a formal relationship with a 
bank or credit union. As you mentioned, without access to 
mainstream financial institutions, working families miss out on 
opportunities for savings, borrowing, and low-cost remittances. 
I personally understand this issue because I grew up in an 
unbanked family. In addition to encouraging the use of banks 
and credit unions for low-cost remittances, can you tell me 
what else must be done to bank the unbanked?
    Mr. Bernanke. Well, the government can provide various 
incentives, encouragements, to banks to do what in many cases 
is really in their own interest, which is to try to reach out 
to these communities. For example, the Community Reinvestment 
Act, which gives credit to banks for providing services, 
including branches in low- to moderate-income communities, is 
one way to encourage banks to take those sort of actions. We 
encourage banks to have multilingual employees, again, to 
establish those relationships.
    But I would hope that banks would see that expanding those 
services into immigrant areas, low- and moderate-income 
communities, is really a way of expanding their customer base 
and increasing the deposits and is really a profitable business 
strategy. So that, I think, fundamentally is the motivation for 
banks to go beyond the narrow groups that they are serving now 
and try to branch out more broadly.
    Senator Akaka. You did mention about predatory lenders. 
Working families are having trouble accessing affordable 
credit. Unfortunately, many working families, of course, turn 
to predatory payday lenders for small loans. My question is, 
what must be done to protect consumers from high-cost payday 
loans, and two, to encourage the development of affordable 
alternatives?
    Mr. Bernanke. Well, the Federal Reserve doesn't directly 
regulate payday lenders. I think that in most cases, they are 
regulated by States who set requirements in terms of the 
information they provide. It is very important for people to 
understand what the cost actually is. If you are paying a 
certain number of dollars until payday, you may not realize 
that as an interest rate, that may be many hundreds of a 
percent or more. So regulatory work at the State level or 
wherever the appropriate level is to make sure that customers 
understand the cost of the credit they are obtaining and learn 
about the alternatives, I think is a very positive direction.
    And in general, as we were discussing earlier, to the 
extent that mainstream banks can come in and provide the 
alternatives and the competition to check cashing and payday 
lending and the like, the better the chance that families will 
have good access to credit and reasonable terms.
    Senator Akaka. Thank you very much for your responses. 
Thank you, Mr. Chairman.
    Senator Johnson. Senator Vitter.
    Senator Vitter. Thank you, Mr. Chairman, very much for 
being here. The Fed's current policy of extremely low, near-
zero interest rates is certainly helping banks recover in 
certain ways. I mean, they can use money to recapitalize 
through buying long-term government bonds. But at the same 
time, that scenario is discouraging, in many ways, getting 
credit out to businesses, to citizens who need it, to the 
recovery. What is your concern about that and how do you 
balance those objectives?
    Mr. Bernanke. Well, as I have discussed earlier in the 
testimony, we have seen a lot of improvement in the broad 
credit markets, in the corporate bond markets and the stock 
market and the like, which means that larger firms have pretty 
good access now to credit. But there is still a big problem for 
people who are bank-dependent, small businesses and consumers 
and the like. It is not an easy problem because we don't want 
to tell banks to make bad loans. We want them to make good 
loans and loans to creditworthy borrowers.
    We have, however, done everything we can, or at least we 
are trying very hard to encourage banks to do that, in 
particular by telling our examiners, training our examiners to 
work with banks to take a balanced perspective. That is, we 
don't want you to make a risky, imprudent loan, but if you have 
a longstanding relationship with a customer who has been 
paying, if you have a creditworthy borrower, you should make 
the loan. It is good for you. It is good for the economy. It is 
good for the borrower.
    So we are supporting that with our examination policy, with 
our guidance. We recently provided some commercial real estate 
guidance which gave examples for how, say, a small business who 
wants to borrow against their place of business, and the value 
of the store has gone down but they can still make the 
payments, why that should be considered still a good loan and 
why you should still make that loan.
    On top of that, we have certainly pushed the banks to add 
capital. You know, since our stress test in the spring, there 
has been a very big increase in the amount of private capital 
raised by the banking system. And we have, as you know, 
increased support of their funding through the discount window 
and through our efforts to get the securitization market 
running again, in particular our program to help investors link 
up with small business lenders, credit card and other consumer-
type loans.
    So we are attacking this from a number of dimensions. We 
are not where we want to be, but we are seeing some improvement 
and expect things to get better as the economy improves.
    Senator Vitter. Well, I guess my more focused question was, 
isn't having extremely near-zero interest rates, in fact, an 
impediment to banks putting more money out to small business 
and others?
    Mr. Bernanke. No, I don't think so. To the extent the banks 
use the money to buy Treasuries, it is because they don't see a 
good lending alternative. So we want them to look at the 
lending alternatives to put out the money. The lower interest 
rates stimulate the demand for credit. Part of the reason--not 
the entire reason, of course, but part of the reason--that bank 
credit is contracting is that the demand for automobiles and 
houses and furniture and other things has fallen in the 
recession and lower interest rates make it more attractive for 
people to buy a car, for example, and that increases the demand 
for credit and brings people to the bank to take out a loan.
    So the purpose of the low interest rates is to strengthen 
the economy, to support employment, and to get us going again. 
As the economy strengthens, that will improve the credit 
situation. It will make credit risk lower, and that should, in 
turn, make banks more willing to lend. So I do think it is 
constructive.
    Senator Vitter. OK. We have talked about the following 
before, but as I have told you before, months ago, it seems to 
me, and it still seems to me, unfortunately, there is a huge 
disconnect between a lot of the discussions we have here and a 
lot of the discussions you have and others have at the Fed in 
terms of trying to, within strong safety and soundness 
parameters, trying to get credit out the door and what the 
regulators down on the ground and folks visiting particular 
institutions are doing in terms of really moving in exactly the 
opposite direction by being so cautious in reaction to what has 
happened in the last year that they are making it virtually 
impossible for community banks to loan new money.
    Just my anecdotal experience is that that hasn't changed, 
hasn't gotten any better since we talked about it several 
months ago. What more can any of us here or the Fed do to 
bridge that divide?
    Mr. Bernanke. Well, we should provide you, Senator, with a 
description of all the various measures we are taking in terms 
of regular conference calls, meetings, manuals, instructions to 
the examiners about how they should be proceeding, and I think 
one useful step that we have taken, for example, in the latest 
commercial real estate guidance is to give lots of examples. 
Here is an example of what a loan might look like, and here are 
the things you should be looking at. It helps people concretely 
to think about how to deal with a loan that may not be perfect 
but still is worth making.
    So we are making a very hard effort to do it. I am sure 
there is some slip between Washington and the grass roots, but 
we understand that issue and the Fed actually has, over a long 
period of time because of our macroeconomic responsibilities 
and our attention to the broad economy, has had a pretty good 
record, I believe. So I don't know which regulators your 
bankers are talking about. We have had a pretty good record of 
trying to balance the needs of the economy and the needs for 
safety and soundness.
    Senator Vitter. Well, again, this is all anecdotal, but the 
experience in Louisiana, particularly in community banks, is 
that the regulators on the ground who are actually dealing bank 
by bank are giving almost all of the signals in the opposite 
direction and they are often reacting to whole categories of 
loans, like anything to do with real estate, and just saying, 
you know, your book is above the line we are drawing now, so 
don't consider anything new, without getting to the merits of 
the loan, even when their portfolio is solid and not falling 
apart. So I would just make that comment again in the same vein 
that we had that discussion several months ago.
    Mr. Bernanke. I appreciate that.
    Senator Vitter. As I am sure you know, The Wall Street 
Journal has criticized you for being part of the mistake of too 
much liquidity and credit around 2003 to 2005 and has doubted 
that you will have the ability or the discipline to rein that 
in at the appropriate time. How do you respond to that 
criticism, and what factors going forward will you be 
particularly focused on in terms of changing that monetary 
policy over time?
    Mr. Bernanke. Well, Senator, there are really two issues. 
Let me talk about first going forward. Clearly, we have put a 
lot of stimulus in the economy in order to try to get growth 
back and get jobs created and credit flowing. But we understand 
that there is another side to it and that includes making sure 
that we keep prices stable, that we don't have inflation 
issues, and even though ideally the financial regulatory system 
would be the first line of defense against bubbles or other 
misalignments in asset markets, given that we do not have 
currently a financial regulatory structure that is really 
designed to prevent those misalignments, I do think monetary 
policy has to pay some attention to those issues.
    And as I mentioned earlier, we are following valuations 
using standard models and metrics to see if we see anything 
that is particularly out of line. It is very difficult to know 
if an asset price is appropriate or not, but we are factoring 
that into our discussion, as was mentioned in our last minutes, 
in fact.
    On the retrospective issue, it remains controversial. You 
know, my own view is that the conventional wisdom in some 
quarters that Federal Reserve monetary policy in 2003 to 2005 
was a principal or major source of the housing bubble, I just 
don't think the evidence is that clear. There are a lot of very 
good economists on the other side of that. One example is 
Robert Shiller, who--perhaps the maven of the housing bubble--
in his view has said it had more to do with mortgage financing 
and psychology than it had to do with monetary policy.
    It is very striking that if you look across countries, for 
example--and the IMF just did a study on this--there is no 
correlation between monetary policy during this period and 
housing prices. So, for example, Canada had similar monetary 
policy to the U.S. as did Germany via the ECB, but neither 
Canada nor Germany had a housing bubble, whereas the United 
Kingdom had somewhat tighter policy and they had a housing 
bubble. So the correlations are quite weak. Now, that is not to 
say that is not an interesting issue we should continue to 
pursue, but I just want to raise some doubt in your mind that 
this is an established fact.
    But the Federal Reserve certainly has a responsibility to 
understand the role of monetary policy in bubbles and to think 
about how we can identify those, as difficult as it is, and to 
try and take that into consideration, where we can, in making 
monetary policy.
    Senator Vitter. OK. In terms of regulatory reform, and in 
particular resolution authority that we are considering, if we 
have an appropriate, in your mind, resolution regime, new 
resolution regime otherwise, would you support taking away 13-3 
and other type authority to send taxpayer dollars to specific 
firms?
    Mr. Bernanke. Yes, I would.
    Senator Vitter. And would there be any subcategory of that 
sort of authority which would send--from either the Fed or 
other entities--to send dollars to individual firms that you 
think we should accept and retain?
    Mr. Bernanke. Well, currently, if the FDIC resolves a 
failing bank, there may be rare circumstances under which the 
Fed would assist by providing short-term liquidity to that bank 
as part of the resolution process. So it is conceivable, and I 
am not saying it has to be that way, but it is conceivable that 
in the resolution authority there might be provisions under 
certain circumstances where the Fed would lend on a short-term 
collateralized basis to the entity. But that is a decision for 
Congress to make. You want to figure out the best way to 
structure the resolution authority.
    I think that if the resolution authority is there, though, 
to go back to your original question, the Fed does not want to 
be involved in bailouts. I mean, we got involved in them only 
because there was not a good legal structure for dealing with 
these firms, and in the future, we have no interest in doing 
that.
    We think there may be some value in having lending programs 
that apply to the economy generally under emergency 
circumstances, but not to individual firms.
    Senator Vitter. OK. Well, again, my concern, as I tried to 
say, is individual firms going----
    Senator Johnson. Would the Senator leave the following 
questions to a second round?
    Senator Vitter. Sure. Thank you.
    Senator Johnson. Senator Tester.
    Senator Tester. Yes, thank you, Mr. Chairman, and I want to 
thank you for being here today, Chairman Bernanke. Over the 
next 4 years, if you are confirmed, you will play, and we have 
referenced it already, a key role in job creation in this 
country.
    Last week, I spent 2 days visiting five of Montana's bigger 
cities--Kalispell, Missoula, Billings, Helena, Great Falls--to 
discuss the economy and jobs. I heard one message consistently 
in each town, and that is we need to allow our local banks the 
opportunity to lend, an issue that Senator Vitter and others 
have brought up.
    At the same time, I am hearing that Fed regulators are 
sending mixed messages. From DC, it is to lend, but from the 
field offices, it is buildup capital, don't consider commercial 
loans. I have heard from several banks that claim the FDIC and 
Fed examiners are overzealous and overreaching and in some case 
reversing State regulatory exams demanding write-downs and 
reclassifications of loans and assets.
    You have made claims here today and before that you are 
pushing banks to lend. The folks on the ground are seeing, for 
the most part, the exact opposite. I believe that Congressman 
Minnick and the House Financial Services Committee sent you a 
letter at the end of October talking about common sense 
regulation on the ground in these economic times. You have 
talked about conference calls. You have talked about meetings. 
You have talked about what you are doing.
    I guess the question is, is there anything more you can do, 
because from what I am hearing, it is not working.
    Mr. Bernanke. Well, I appreciate the feedback, and all I 
can say is we will take another look at it and try to step it 
up further because it is important to have a balanced 
perspective.
    Senator Tester. But you do agree that these local banks 
play a critical role and the capital they provide play a 
critical role in job creation, and if they are bound up and do 
not loan money because regulators are putting the boots to 
them, the economic recovery is going to be slow in coming?
    Mr. Bernanke. That is true, but we do have to make sure 
that they are making good loans. We don't want to go back into 
a situation where they are making bad loans and then it ends up 
costing money for the Deposit Insurance Fund. But subject to 
that, obviously, we want them to make good loans.
    Senator Tester. I would agree with that. I guess the real 
question then becomes, what is the definition of a good loan?
    Mr. Bernanke. One that gets paid back.
    Senator Tester. OK, and so what determines that?
    Mr. Bernanke. Well, a set of criteria about----
    Senator Tester. And have those criteria changed?
    Mr. Bernanke. The criteria haven't changed. What has 
changed is the economic environment. You have people whose 
business has deteriorated or whose asset values have declined 
and it makes them less creditworthy. But again, we have tried 
through our policies, to identify the key issue--the ability to 
repay--which may not be the same, for example, as the 
collateral value. So we want to identify criteria that will 
help banks make loans to people who will repay and can repay, 
but be careful obviously about not making loans that are not 
likely to be good.
    Senator Tester. There is also a perspective out there that 
the playing field is tilted to the big guys. Could you comment 
on that? I am talking about the big financial institutions, and 
that the little guys who really didn't create the problem are 
doing all the suffering and the big guys are back making 
incredible profits and that the playing field is tilted toward 
them. Could you talk about that for a second?
    Mr. Bernanke. I will. We have an enormous too big to fail 
problem in this country. All the problems that people are 
talking about, the bonuses, the unfair playing field, 
government backstops, moral hazard, all of that follows from 
too big to fail, and the best thing that we can do to solve 
that problem, to create market discipline for those big firms, 
to force them to compete on an even playing field, is through 
regulatory reform that will address too big to fail, and I 
think that basically has two components.
    One component is tougher regulation for these large firms, 
higher capital requirements, tougher liquidity, supervision, 
and risk management requirements on the one hand, but on the 
other hand, going back to Senator Vitter's comments and others, 
a resolution regime that will allow the government in a 
situation of crisis to wind down, allow a firm to fail, and 
allow creditors to take losses without having all the 
collateral damage to the financial system and the economy that 
we saw last fall.
    Senator Tester. OK. And if you have already stated an 
answer to this question, I apologize, but I really don't know 
this. The Chairman of this Committee put out a regulatory 
reform bill. Does it adequately deal with the too big to fail 
issue?
    Mr. Bernanke. I believe it addresses the resolution issues. 
Senator Dodd knows that I disagree about the Federal Reserve's 
role on the regulatory side. We think we both have the 
appropriate expertise and the need to know, so to speak, that 
we should be involved in oversight of the banking system.
    Senator Tester. OK. So taking the turf issue out, if you 
can do that, because I know you are looking to be confirmed for 
this job, taking the turf issue off the table, does that bill 
adequately address the too big to fail?
    Mr. Bernanke. Well, it is not a turf issue, it is a 
fundamental issue about the soundness of the plan. But putting 
that aside, at least on one side, which is the resolution 
regime, I don't want to--let me be quite frank. I haven't read 
the latest version and I know right now we are in discussions 
and so on----
    Senator Tester. There is still work----
    Mr. Bernanke. ----but broadly speaking, it had the features 
that a firm would be able to be wound down, that losses could 
be imposed. If I understand that correctly, then that is where 
we should be heading, in that general direction.
    Senator Tester. OK. Well, there is some----
    Chairman Dodd [presiding]. I take that as a wild 
endorsement.
    Senator Tester. Yes, exactly.
    [Laughter.]
    Mr. Bernanke. It is a strong endorsement, Senator.
    Senator Tester. I was trying to help you out, Mr. Chairman.
    While some of the folks in Congress recommend using TARP 
funds to spur lending in local markets, Montana is only one of 
two States that receive no Capital Purchase Program funds. Our 
banks don't want TARP funds. So what other recommendations 
would you propose to spur some small business lending, rather 
than TARP?
    Mr. Bernanke. Well, I think we have to address your 
regulatory issue that you raised. We are trying to strengthen 
the secondary market so that banks that make a small business 
loan can then package it and sell it; we have made a lot of 
progress in restoring the secondary market for SBA loans and 
also for commercial real estate loans. Those are the main 
suggestions I have.
    Senator Tester. All right. I just need to know your 
thoughts on an idea that has been bounced around here a bit, 
was bounced around a little bit in Montana, the New Employee 
Tax Credit concept, providing business a credit if they bring 
on a new employee and keep them for 2 or 3 years or whatever 
that arbitrary figure might be. It has been done before. What 
is your perspective on it?
    Mr. Bernanke. Well, I don't think we have a clear answer to 
that question, unfortunately. The historical record is mixed. 
Some have been perceived as successful, some not so successful. 
So there is not a clear enough consensus that I would want to 
make a recommendation to you, particularly since I just 
promised Senator Corker I wasn't going to make fiscal policy 
recommendations.
    Senator Tester. But we are talking jobs.
    Mr. Bernanke. Yes, I know, and there are a lot of different 
ways to approach jobs and I am sure you have seen the list. I 
mentioned earlier Christina Romer's op-ed in The Wall Street 
Journal which listed the five or six items that people are 
looking at. I would have to say that some of the others she 
mentioned are more straight forward and we would have a better 
sense of what the effect would be, but the Jobs Tax Credit, one 
of the drawbacks is we don't have a sense of how strong an 
effect that would have or how permanent the effect would be.
    Senator Tester. Regardless of how it is structured?
    Mr. Bernanke. Well, it would depend a lot on how it is 
structured and how it is publicized and to whom it applies and 
so on, and that is part of the reason I can't give you a clear 
answer.
    Senator Tester. OK. If we had a more concrete proposal, you 
could?
    Mr. Bernanke. We could help you analyze it. But again, I am 
reluctant to make a----
    Senator Tester. I understand.
    Mr. Bernanke. ----a clear recommendation.
    Senator Tester. Sounds good. Thank you very much.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator, very, very much.
    Senator Johanns.
    Senator Johanns. Mr. Chairman, thank you for being here. I 
will just show bias to start out. I have always believed that 
less government and lower taxes helps create jobs. But let me 
pursue something with you.
    I think the biggest challenge that you face in your job is 
maybe not what you have been through, although that was 
significant, it is what you do from here, because at some 
point, there has to be a very artful exit strategy. You have 
done some things, or the Fed has done some things that have 
really, really been unprecedented. It has gotten a lot of 
debate, a lot of concern. Some have agreed with you. Some have 
vehemently disagreed with you. I think that is reflective of 
what has happened with the Committee today.
    I would like you to just walk us through the things that 
the Fed has in place, everything from your policy with 
Treasuries to interest rates, and talk to us about the exit 
strategy, number one, and what timing--and I am not necessarily 
looking for, by June 1, we will do this. What I am looking for 
is what economic signals will cause you to reach a conclusion 
that we can pull back from this or we can do that? So talk to 
us a little bit about that.
    Mr. Bernanke. Certainly. Well, first, as you know, the 
Federal Reserve created a number of special programs to try to 
address problems in specific markets, like the commercial 
paper, the interbank market, the money market mutual funds, a 
variety of areas where there were stresses, we created special 
facilities and the like to try to reduce those stresses.
    As things have improved, the demand for funding from these 
programs has dropped significantly. We are down now to about 15 
percent of the peak in terms of the dollars outstanding through 
these various programs. So we have made a lot of progress just 
through the fact that demand has gone away as the markets have 
improved in reducing all these programs, and, we will be 
cutting back the size and closing them, first, as market 
conditions normalize, as they continue to do, and in 
particular, those programs are justified only under so-called 
unusual and exigent circumstances, and as markets normalize, 
from a legal perspective we will need to be thinking about 
closing them down, and we are moving in that direction. And, 
again, we have made a lot of progress in that direction at this 
point.
    Beyond that, our major programs have been asset purchases. 
We had a Treasury purchase program which brought our holding of 
Treasury bonds about back to where it was before the crisis, so 
we really have not increased our holdings of Treasuries. But we 
have also had a very big program of purchasing Fannie Mae, 
Freddie Mac, and other GSE mortgage-backed securities. We have 
announced that the current program will be wound down, tapered 
off through the first quarter of next year, and that is 
currently on schedule.
    So what we have is, if you will, a rolling exit process 
whereby the special programs are running off just because of 
lack of interest, and they will be shut down over time. We have 
bought a lot of Treasuries and MBS, though at this point we 
have announced tapering off of those programs.
    The next step at some point, when the economy is strong 
enough and ready, will be to begin to tighten policy, which 
means raising interest rates. We can do that by raising the 
interest rate we pay on excess reserves. Congress gave us the 
power to pay interest on reserves that banks hold with the Fed. 
By raising that interest rate, we will be able to raise 
interest rates throughout the money markets. And we can support 
that through a number of mechanisms that we have developed to 
reduce the size of the balance sheet and the amount of reserves 
in the system. And so we will do that gradually over time.
    So from a technical perspective, we have plenty of clarity 
about how we can exit from all these programs and how we can 
tighten policy and how we can, you know, raise interest rates, 
remove the accommodation at the appropriate time so that we get 
a sustainable recovery without inflation.
    Of course, as always, the communication, the timing, and so 
on is difficult. It always is, coming out of a recession. But 
it is not especially difficult in the sense that all these 
various programs and unusual steps we have taken we have good 
means now of reversing them and unwinding them as the time 
comes.
    Senator Johanns. As we look out to just next year, let us 
say, the next 12 months, we already have unemployment that has 
now gone over 10 percent, probably--well, not probably. It is 
much higher than that if you count people who have just given 
up. That number is in the 17-, 17.5-percent range, from what I 
understand. We are a consumer-driven economy, so if you have 
got a whole bunch of consumers very much on the sidelines just 
trying to keep things together as best they can. You have got a 
whole bunch of other consumers worried about losing their jobs.
    As you look out there over the next 12 months, what is your 
expectation when it comes to unemployment numbers? And is this 
going to get worse before it gets better, is kind of the bottom 
line of where I am headed with that question?
    Mr. Bernanke. Well, the unemployment rate is very high, and 
it is a tremendous problem, and it obviously means a lot of 
hardship for a lot of people and some very long-term scars in 
the labor market.
    The rate at which the unemployment rate comes down is going 
to essentially depend on how fast the economy grows and then 
also how much confidence employers have to bring more workers 
on.
    We have an employment number tomorrow. We will get a near-
term reading of what is happening. I do not know what the 
number is, but most forecasts right now are still for job loss. 
But as the economy continues to grow, we should begin to turn 
that corner and start to see job creation. However, because we 
have people coming into the labor market all the time, you need 
to have a certain amount of growth just to absorb the new 
entrants into the labor market. So you probably need something 
like 2.5 percent growth in the economy just to absorb those new 
entrants and keep the unemployment rate more or less stable.
    Right now, the FOMC expects growth next year to be fairly 
moderate, somewhere in the 3.5-percent range, and what that 
suggests is that over next year we will see the unemployment 
rate declining but, unfortunately, slower than we would like. 
It depends also in part, again, on employers. Employers have 
been very effective in increasing productivity and reducing the 
amount of labor that they need to produce output. Our sense is 
that they cannot keep up that kind of cost saving indefinitely. 
At some point, as the economy begins to expand, they will have 
to bring back some workers. But to the extent that cost savings 
and those kinds of labor reductions continue, that will be 
another drag.
    So the bottom line is we do not really know--our 
forecasting is far from precise--but if, in fact, the economy 
grows at a moderate pace, as we expect, the unemployment rate 
should peak and then come down, but only slowly.
    Senator Johanns. My last question. One of the things I hear 
as I talk to the business community, not only in my home State 
of Nebraska but those who come into my office, is they just 
feel there is a tremendous amount of uncertainty that is 
causing anxiety about decision making in terms of investment, 
capital expansion. Even when they see the business pick up, 
they are very, very reluctant to add people. And here is the 
uncertainty that they talk to me about. They talk to me about 
climate change legislation and the impact that that will have. 
They talk to me about card check and the impact that that would 
have on their business, the impact of regulatory reform, the 
impact of health care reform, and that has a real financial 
impact on them.
    How big a problem is that in terms of our economy starting 
to find its equilibrium, stabilize itself, with all of those, 
you know, really exorbitant things going on out there impacting 
that psychology of the marketplace?
    Mr. Bernanke. Well, we have heard the same thing in our 
discussions. You know, the FOMC has Reserve Bank presidents 
from around the country, they talk to business people as well, 
and they bring that message to us, and they have heard a lot 
about concerns about uncertainty.
    One place where it is particularly relevant to the Federal 
Reserve is as we think about financial regulatory reform and 
capital requirements and so on, one reason why banks may be a 
little bit reluctant to lend is that they do not know what the 
capital standard is going to be, they do not know what the 
regulatory standard is going to be, and that creates some 
uncertainty for them as well. So it is an issue.
    I do not have any real way of measuring in percentage 
points how big an effect this is. It is certainly something we 
hear a lot. My guess is that it will not be in itself a reason 
that the economy cannot grow. But it does probably mean that 
firms will wait a bit longer to hire. Maybe they will start 
with temporary workers. Maybe they will start by bringing back 
part-time workers to work full-time. Maybe they will use some 
overtime.
    So I do think it may contribute to some extent to the 
slowness at which firms make the commitment to make new capital 
investments and to bring workers back that they have let go.
    Senator Johanns. Thank you, Mr. Chairman.
    Chairman Dodd. Senator, thank you very, very much.
    Senator Bennet.
    Senator Bennet. Thank you, Mr. Chairman, and welcome, Mr. 
Chairman. Thank you for hanging in there with us today. I am a 
little under the weather.
    One of the great benefits of being at the end of this 
horseshoe is that you get to hear everybody else's questions 
and your answers. One of the enormous frustrations to me over 
the last months and weeks--and I am sure it is frustrating to 
you, too--is to sit here and listen to Senator after Senator, 
myself included, talk about what we are hearing anecdotally on 
the ground about lending to small business, to hear the stories 
of small businesses that are maxing out their credit cards 
because they cannot get access to capital of the banks, to hear 
from community banks that they are unable to lend because they 
believe the examiners are not giving them the headroom they 
need to lend. And every time we have this conversation, you 
answer, wisely and well, which is you say we are doing 
training, we have guidelines, and, of course, we do not want 
people to lend poor loans, and no one here wants that either.
    And I guess my question for you is: Is there a way we can 
move beyond this conversation to a place where we can actually 
acquire evidence of whether or not lending is going on in our 
communities? Is the tightness of the credit related to the fact 
that we do not have good credit risks? Or is it that we are 
overcautious? I mean, how will you evaluate that? How do you 
know that your training has worked? How do you know that your 
guidelines have worked? How do you know what is actually going 
on in the State of Colorado or the other States that are here? 
Because what I do not want to do is go through another hearing 
and another month and another week where we do not know what 
the evidence really is of what is going on on the ground.
    Mr. Bernanke. Well, it is intrinsically very difficult to 
have statistics on how many good loans were not made, because 
obviously if we knew which loans were good, we could just 
instruct the banks to make them, and it is their credit 
judgments which are so difficult.
    What we do, one metric we have----
    Senator Bennet. I might agree with you prospectively, but, 
I mean, even retroactively, if we could look at what has 
happened--your choice on the period of time--so that we could 
take the anecdotal evidence that we have and the efforts that 
you have made and try to see whether those efforts are 
successful or not. Because if it has not been successful, if 
people go to the trainings and then come back and do not follow 
the guidelines that you have given them, or if we are being too 
conservative--and, believe me, I would not--I stipulate to the 
view that we should not do bad loans. How are we going to know 
that or not? And the reason it is so important to me is I do 
not see any way to get this unemployment rate down without 
having our small businesses have access to credit. And I think 
you have heard that universally today.
    Mr. Bernanke. I have heard it, and I will give it some more 
thought. I think one statistic that we have is we do survey the 
senior loan officers of a large number of banks on a quarterly 
basis, and we ask them a whole bunch of questions about demand 
for loans and what they are seeing and so on.
    Senator Bennet. Right
    Mr. Bernanke. And one thing that has been very clear is 
that the tightness of lending standards imposed by the banks 
themselves are at record tight levels, so it is not just the 
regulators.
    Senator Bennet. So here is what I--I mean, first of all, I 
for one would be very willing to work with you and your staff 
on this because we have got to move past this he said/she said 
aspect of what is going on. You know, you have the regulators 
or the examiners saying one thing is true. We have an 
observation like the one you just made about banks holding onto 
capital saying that that is the issue.
    I just feel like we are being guided by sort of vague 
impressions of what might be going on out there when the people 
that actually cannot keep their doors open and feel that they 
are good credit and that they are able to pay cannot get access 
to credit. And they may be wrong. In other words, their credit 
may not be good, but I can tell you there is an avalanche of 
that feeling that is out there, and I would like to be in a 
better position to say here is what is really going on, or at 
least to be able to say, you know, the examiners and the banks 
and the people in Washington have somehow convened together to 
try to diagnose the issue so that a month from now we can say 
things are getting better, or we can say things are getting 
worse, or we have not moved off dead center. But we have no--
the frustration is that we have no measuring stick at all, 
really, other than people's impressions.
    Mr. Bernanke. Other than surveys and data on the kinds of 
loans being made. The Fed staff did work----
    Senator Bennet. But we would not run our business that way. 
I mean, it would not be just based on survey data. Survey data 
is useful, but it----
    Mr. Bernanke. I was going to add--I am sorry. I was going 
to add----
    Senator Bennet. I apologize.
    Mr. Bernanke. The Fed staff did work with the Treasury 
trying to develop metrics for the TARP program to what extent 
did it lead to higher lending. And there was, I think, some 
progress made there. But your point is very well taken. I have 
heard this many times, as you can imagine, and I will take this 
back to our staff and see if we can figure out some more useful 
metrics or ways of thinking about this problem.
    Senator Bennet. OK. I think, again, it is because of the 
consequence of my sitting here at the end that I can hear the 
same conversation over and over and over again. Other people 
may not.
    Mr. Bernanke. As you can imagine, I have heard it many 
times.
    Senator Bennet. I know. And I just think it would be useful 
to everybody if we were able to agree upon a set of metrics 
going forward. And, again, I would offer to help.
    You mentioned something early in your testimony this 
morning about the importance of withdrawing from this economy 
in a way that creates jobs. I may be putting language in your--
I think I wrote it down. ``In a manner that promotes job 
creation'' is what you said, something like that. Could you 
talk a little bit about that?
    Mr. Bernanke. Withdrawing the policy accommodation you 
mean?
    Senator Bennet. I just wanted to know what you--no. 
Withdraw your balance sheet from our economy.
    Mr. Bernanke. Right. So as part of the normalization of 
monetary policy, right now monetary policy is quite supportive 
of economic growth. We have near zero interest rates. We have a 
large balance sheet. We have a number of programs to try to 
keep down interest rates or to improve functioning in key 
credit markets.
    As I was describing to Senator Johanns, we will have to 
unwind those programs, and we have a set of ways of doing that. 
But basically the trade-off is the same one that we usually 
face when we come out of a recession, which is that at a 
certain point we have to begin to scale back the amount of 
stimulus we are providing for the economy so that we do not 
overshoot and create inflation or other problems down the road. 
And that is a judgment call because monetary policy takes some 
time to work.
    So all I was saying there was that we are going to have to 
find sort of the right moment, the right communication, so that 
we can begin the withdrawal of stimulus or continue--we have 
already really in some sense begun that process by reducing 
some of the size of our programs, for example--how to withdraw 
that stimulus in a way that will avoid any side effects like 
inflation or asset bubbles or any other problem, but at the 
same time be consistent with a sustainable and increasing 
expansion. That is the challenge that we always face at this 
stage.
    Senator Bennet. OK. Thank you, Mr. Chairman. I appreciate 
it, as always.
    Chairman Dodd. Senator Bennet, thank you very, very much.
    Senator Gregg.
    Senator Gregg. Actually, I think Senator Hutchison was here 
earlier, came back, and----
    Chairman Dodd. I apologize. You are correct.
    Senator Hutchison, I apologize to you. Senator Hutchison, 
my apologies.
    Senator Hutchison. Thank you, Mr. Chairman, and thank you, 
Senator Gregg. I appreciate that note.
    Thank you, Mr. Bernanke, for coming to be with us in what 
has obviously been a long hearing, and I appreciate that you 
are here.
    During your appearance before the Committee in July, we 
spoke about the effect that the proposed health care reform 
would have on our fiscal policy and the economy as a whole. At 
that time, you said that when considering health care reform, 
cost must be an issue, must be the issue.
    The Democrats' proposal has now come to the floor, and we 
see that it has a $2.5 trillion price tag over the 10 years 
from when it starts in 2014 to 2023. Yet according to the CBO 
the huge Government takeover of health care is not going to 
lower health care costs, and, in fact, insurance premiums for 
every individual and family will go up, and I think if we are 
going to look at how we can change that cost curve, we need to 
have the ability to determine not only how to do it, but what 
is going to be the long-term effect of the $2.5 trillion price 
tag that is going to be on it on our long-term economic 
situation. And I would like to ask you what you think it will 
be.
    Mr. Bernanke. Well, Senator, as I said last time, I think 
the real issue is health care costs--not just the total bill in 
some sense, but what does it do to the industry, what does it 
do to the cost of care per person. And what we have seen over 
the last 30 years or so is that health care costs per person 
are rising about 2.5 percent a year faster than income, and 
that is not sustainable. Obviously, at some point health care 
would become the entire economy.
    So what I consider to be the key issue, given that the 
Government has exposure to Medicaid, Medicare, and other costs, 
is finding ways perhaps not immediately but over a number of 
years to bring down the cost per person of health care.
    I have not read the CBO study. I know enough to know that 
health care economists have differed quite a bit about 
implications of different proposals and different measures. So 
I am not going to weigh in with a number. I do not have a good 
number to give you, only to repeat what I have said before, 
which is that as part of this process, it is very, very 
important that we do our best not to reduce the quality of care 
or reduce coverage or to make health care worse. This is a very 
inefficient system, and there must be ways to reduce the cost 
of delivering the health care, and many ideas have been 
suggested, ranging from information technology to various 
incentive payments to experimental or evidence-based medicine.
    I just want to reiterate that because it is critical that 
we get a stable and sustainable fiscal trajectory going 
forward, we do need to address this issue, and I do not think 
we can get a sustainable fiscal situation without addressing 
the issue. But, again, in terms of the specifics, there is a 
lot of disagreement about exactly how much effect on individual 
health care costs this bill will have. But I would just urge 
Congress to continue to look for savings, ways of reducing that 
cost.
    Senator Hutchison. Well, if I understand, what you are 
saying is that you have not looked at the numbers yourself, but 
if it is, in fact, going to increase the costs of premiums to 
every family and the overall cost to every individual, every 
business, as well as to the Government, that would have a 
harmful effect on our economy long term?
    Mr. Bernanke. If that is the case, higher costs to the 
private sector increase the cost of doing business, reduce 
wages. Higher costs to the Government means a higher fiscal 
deficit, all else equal, and that has potentially significant 
consequences for interest rates and for capital formation and 
for the health of the economy.
    So, clearly, it is a very, very crucial issue that we try 
to address the cost issue in health care.
    Senator Hutchison. Thank you. We share your concern.
    Let me move to the financial regulatory policies that 
Chairman Dodd has put a bill forward. A bill has also come out 
of the House. And one of the issues is the too-big-to-fail 
issue, and I think every one of us is concerned about it. We 
have different approaches to that issue, but let me ask you 
this: In Chairman Dodd's proposal, there is a systematic risk 
resolution mechanism that would allocate the risk, attempts to 
allocate the risk, and it would exempt community banks at the 
$10 billion or below level.
    I have concerns about using the asset test because at $10 
billion you could include funds that are highly leveraged and 
inherently risky to our financial system. But you would also 
exclude asset-heavy mid-market community banks that pose no 
threat.
    Do you have a recommendation, as we are working through 
this, for how you could measure a financial institution's risk 
so that we ensure that it is not a safe and sound community 
bank that is paying for the too-big-to-fail policy risk that it 
will not have a part in producing nor profiting from? Because I 
do not think any of us wants another taxpayer bailout. Many of 
us are very concerned about the one that is before us now and 
not being used the way we were told it would be used. But, 
second, I am very concerned about putting any more burden on 
our community banks, which are trying to lend and trying to 
have an impact for business that would give them liquidity. And 
so I want to protect those community banks from having to pay 
for the risk of too big to fail so that the taxpayer does not 
have to do it, nor do they.
    What would you suggest is the best measure to determine who 
should pay for the risk so that taxpayers will not going 
forward?
    Mr. Bernanke. Well, a relatively simple thing to do--and 
this is just one suggestion--would be to exempt all insured 
deposits, that is, do not make people do a liability test, but 
excluding deposits for which the premiums are being paid to the 
FDIC, which seems fair. And beyond that, it would in practice 
exempt most community banks that have primarily deposit-based 
funding, and perhaps some additional exemption above that. So 
that would be one approach.
    A more difficult approach would be to try to do the analogy 
to what the FDIC does now, which is to make the premiums risk-
based in some way, have it depend on some estimate of how the 
firm would be affected if the financial crisis did hit the 
system, and that would depend on things like the riskiness of 
the positions that the bank takes, which affects the FDIC 
premium. It might be affected by its funding mix. It might be 
affected by the complexity of its operation and a variety of 
things.
    As you can see by my answer, I think that would be a very 
complicated thing to do, so my first guess would be to try to 
find a formula that exempts deposit-funded or community-sized 
banks for the most part and it puts most of the weight on firms 
that do a lot of proprietary training and do a lot of riskier 
types of activities. Doing it based on uninsured deposits would 
be one first cut at that.
    Senator Hutchison. My time is up, but I thank you very 
much.
    Chairman Dodd. Thank you, Senator, very much.
    Let me turn to Senator Gregg.
    Senator Gregg. Am I it?
    Chairman Dodd. Well, you may be. I think maybe my colleague 
from Alabama may have another question or two. Senator Merkley 
is coming back, as well, so you are not the last person.
    Senator Gregg. Mr. Chairman, first, I want to say thank 
you, thank you on behalf of people who live on Main Street in 
New Hampshire. The simple fact is that if you hadn't been there 
and been willing to take extraordinary action last fall and 
into last winter and the early spring, along with Secretary 
Paulson and Secretary Geithner, this country would be in a 
catastrophic financial situation right now, and it is very 
likely we would be experiencing a depression or potentially a 
depression, but certainly a recession which would be radically 
more severe than what we have experienced, which has been bad 
and terrible for a lot of people.
    The way I describe it is it is like people driving over a 
bridge that was about to fall down. They didn't know that there 
was somebody under there who fixed it so it didn't. They don't 
give you credit. But the fact is, you did take the action that 
was necessary and it was a very aggressive and creative action, 
as you have acknowledged. Over $2 trillion, it looks like to 
me, from your portfolio went into trying to make sure that our 
financial institutions remained liquid during this difficult 
time.
    So I respect what you did. I obviously don't agree with 100 
percent of it, would have done some things differently, but I 
didn't hold the magic wand, nor did any of us at this table, 
and I think the proof is in the pudding, which is that we are 
coming out of this recession and the world didn't devolve into 
chaos, fiscal chaos, which it might well have done had you not 
taken that type of initiative.
    There are a lot of big issues now pending as a result of 
that as we try to reorder the way that we approach the 
structure of our financial institutions in this country, and 
what I think is critical, and I have said it before on this 
Committee, is that as we do that, we not undermine what is our 
great and unique strength as a nation, which is that we are 
able to create credit, we are able to create capital, and we 
are able to advance credit and capital to entrepreneurs in a 
manner that no other nation has ever done. And as a result, 
people who have ideas and they are willing to go out and take 
chances and create jobs can find the resources to do it.
    And as we advance this effort in the area of financial 
regulation, we have got to be careful we don't create 
unintended consequences of limiting that advantage that we have 
against the rest of the world. The rest of the world has some 
advantages over us. That is one of our big advantages over 
them.
    And so how the Fed is postured in this is critical, because 
you are at the epicenter of the structure of our financial 
institutions, of our credit institutions, and of our monetary 
policy, obviously. And thus, I am concerned, deeply concerned 
about this, I call it pandering populist movement out there to 
basically step onto monetary policy, have the political 
entities of this country step onto monetary policy.
    You have already spoken out against it well and eloquently. 
I just want to second what you said. I know Secretary Summers 
did a study on this. You have obviously studied it as an 
economic historian. But I can't think of a nation where the 
value of its currency was turned over to or even marginally or 
significantly influenced or even marginally influenced by 
elected officials that that nation has prospered. Usually, that 
is an absolute recipe for inflation and an absolute recipe for 
other nations looking at the nation that allows its political 
process to set the value of its money as risky, if not 
detrimental. And we are too big and too important to the rest 
of the world to allow that to happen here.
    And I understand it is an easy political vote. Go out and 
beat up on the Fed. You are that mysterious event. You could be 
in a Dan Brown novel, I guess. But the simple fact is that you 
are there because we recognized early as a Nation in this 
century--the last century--that it was important to keep 
monetary policy separate from fiscal policy, and monetary 
policy independent. So that is a long explanation of support 
for your position and unalterable opposition to stepping into 
this issue.
    You are, as you said, audited in every area in a very open 
and aggressive way, and we have the access to those audits, 
everybody has the access to those audits except on the issue of 
monetary policy and that is the way it should be.
    I want to get into this too big to fail issue, because I 
haven't figured out how we address this yet, but there is a 
proposal that came out of the House Banking Committee that said 
that healthy, well capitalized, vibrant, energized institutions 
which have no definable risk to them will be subject to the 
potential break-up, and that break-up will be determined by an 
independent group of politically appointed people, or maybe 
even Members of Congress, for all I know, under the structure, 
arbitrarily. I mean, that, to me, is a European model of 
governance that is very threatening because there, big is not 
necessarily bad. In fact, in many instances, it makes for a 
competitive advantage. If these institutions are solvent and 
they are structured well and they are competing, they give us 
an economic advantage.
    It would be incredible industrial policy for a group of 
politicians to come in and say, well, you are too big, and we 
don't like you because you are too big, therefore, we are going 
to break you up. I mean, where does that stop? Does it stop 
with Wal-Mart because we don't like the fact that they aren't 
unionized? Does it stop with Coca-Cola because they produce a 
product that some people think adds to obesity? Does it stop 
obviously with Altera? I mean, where does that stop, when you 
get on that slippery slope of functioning, strong companies 
that are big, but represent no risk because they are 
functioning and they are strong?
    So I guess I would ask you, obviously, too big to fail is a 
big issue for us and it has got to be addressed, but shouldn't 
that be addressed on the issue of the institution being a risk 
as versus the institution just plain being big?
    Mr. Bernanke. So my preferred approach to too big to fail, 
which I agree with you is perhaps the central issue in 
financial reform or certainly one of the very biggest ones, has 
two or two-and-a-half components, depending on how you count. 
One is to offset some of the incentives to become too big to 
fail and to take into account the additional risks that a very 
large firm may pose to the system----
    Senator Gregg. By raising their capital requirements over 
other----
    Mr. Bernanke. By raising capital requirements or making 
sure they are safe, making sure they have enough liquidity----
    Senator Gregg. Which is a function of making them safe.
    Mr. Bernanke. So that is the regulatory approach, and I 
think that should be part of it.
    The other part is to have market discipline, and the way to 
have market discipline is to have the ability to fail. We have 
talked about this several times today, but it is absolutely 
crucial that when people lend money to a large financial 
institution, that they are doing due diligence and looking at 
the riskiness and the activities and the profitability of that 
institution and not making their loan based on assumed 
government support of that institution. And so----
    Senator Gregg. There is no implied guarantee that an entity 
can survive, that the stockholders are at risk, as are the----
    Mr. Bernanke. Under our current system, when we say that we 
are going to let these firms fail, it is not entirely credible 
because everybody sort of knows that if we come to a huge 
crisis and we are trying to protect the system, we might 
intervene, as we did. So we need to make it credible, and one 
way to make it credible is to have a set of rules and laws that 
allow us safely to let firms fail so that their failure doesn't 
affect the broad system and the broad economy. So those two 
items.
    And on size, et cetera, I agree size is not a particularly 
good indicator of riskiness or even danger to the financial 
system. I think it would be worthwhile to consider, for 
example, whether regulators might prohibit certain activities. 
If a financial institution cannot demonstrate that it can 
safely manage the risks of a particular type of activity, for 
example, then it could be scaled back or otherwise addressed by 
the regulator under some circumstances.
    But I think those are the elements that would solve the 
problem, particularly the first two, the tougher regulation and 
the resolution regime.
    Senator Gregg. Well, I will take your comments, then, as 
saying that simply because a company is large is not a reason a 
group of politicians should step in and break it up.
    Mr. Bernanke. No, I think we should all recognize that size 
and complexity often have economic benefits and we should, as 
much as possible, let the market decide. And one of the many 
advantages of getting rid of too big to fail is that ability to 
obtain funding and sell shares, et cetera, depends not on the 
government's backstop, but on the economic value of the 
operation.
    Senator Gregg. If I might be indulged for one more second, 
not to imply that the Chairman's proposal falls in that 
category of what I am concerned about. What I am concerned 
about is the Kanjorski, I think is his name, the language that 
came out of the House. How do you feel about this idea of 
requiring large institutions to have a living will? Does that 
create a--is that a situation where you have, almost by saying, 
well, you have got to have a living will, therefore you are 
maybe being given the imprimatur of too big to fail, or does it 
actually give the opportunity to say that that is not the case?
    Mr. Bernanke. I think living wills, while they are not a 
panacea, can be a useful adjunct to supervision. What a living 
will does is essentially describe how the bank or financial 
institution would unwind itself. And the reason that can be 
important, as we found out with Lehman Brothers and others, is 
that in many cases for tax reasons or for international 
reasons, whatever, financial institutions are extremely 
complicated from a legal perspective and it is very, very 
difficult and complicated to unwind them when the time comes.
    So it would be helpful, even in a planning sense, for us to 
understand how the firm is structured, what its legal 
connections are, and in situations where extraordinarily 
complex legal structures are there for tax avoidance or other 
less economic reasons, maybe there would be a case for looking 
for a simpler structure in some cases. But I think it would be 
a useful tool, not only in the actual crisis or in the actual 
wind-down, but in the process of understanding how the firm 
works and whether or not simplification in terms of its 
structure might be beneficial.
    Senator Gregg. Thank you.
    Chairman Dodd. Thank you very much, and just for the 
purposes of the public, we are not talking about death panels 
here now in living wills.
    [Laughter.]
    Chairman Dodd. That is a separate hearing. That is another 
committee that deals with those issues here.
    Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair, and thank 
you for your testimony, Chair Bernanke.
    Several times today when you have been asked about too big 
to fail, you have emphasized the power to unwind the 
institution. You mentioned in passing in one of your replies 
the issue of risk that goes from one company to another, but I 
don't think you specifically talked about it in terms of the 
role of derivatives. There are folks who would say that 
derivatives are the issue in too big to fail because that is 
why we intervened. It is not to save this one financial 
institution, but because through derivatives, the consequences 
of their failure are transported to so many other financial 
institutions.
    And so I was wondering if you could maybe elaborate on that 
piece of the puzzle, of the role of derivatives in too big to 
fail and how you think that we reduce that risk.
    Mr. Bernanke. I don't think that derivatives are by any 
means the only issue. One example would be that we have had 
very destructive financial crises in the 1930s and in other 
contexts where derivatives weren't really much of an issue at 
that point. But clearly in this crisis, they were a big issue, 
and one of the main problems was that they weren't 
appropriately overseen, which meant in many cases they were not 
protected by capital reserves. The classic case would be AIG, 
which had a lot of one-way bets, one-directional bets, but even 
though it was a kind of insurance they were selling, because it 
wasn't regulated, they didn't have reserves or capital behind 
that, and then, of course, when the bet went wrong, then the 
company came under a lot of pressure.
    One thing that the AIG example illustrates, by the way, is 
that derivatives have not only the risk associated with the 
outcome of the underlying security, but also counterparty risk, 
so that those people who were holding AIG insurance faced not 
only the possibility of loss because of the underlying, but 
also because of the possibility that AIG could not pay. So 
clearly, making derivatives safer, both in an operational 
sense, in the way they are traded, but also in terms of 
protecting against counterparty risk, is a very important part 
of this reform.
    I agree with proposals that have been made that derivatives 
that can be standardized, and that is quite a few of them, and 
are accepted by central counterparties or exchanges or 
clearinghouses for clearing on those institutions should be 
traded on a central counterparty, which would be an 
organization which, by taking margin and holding capital, 
essentially ensures against counterparty risks, protects the 
participants against counterparty risks.
    Also, by having trading on a clearinghouse, we will have a 
much more transparent situation. People will know what 
outstanding positions look like. There will be no problems, as 
we had with credit default swaps, with transactions which are 
not cleared in a timely way so there is confusion about who 
owes what to whom.
    So I do think that strengthening the infrastructure 
generally--settlements, payments, clearing--but in particular, 
making sure derivatives are traded, where possible, on a 
central counterparty or on an exchange, is an important step to 
making the system stronger, and it ties into too big to fail in 
a couple of ways. One is if you get rid of the counterparty 
risk, you reduce the contagion. So in the case of AIG, if AIG 
had failed, the implications for the counterparties would have 
been less because the counterparty risk would have been 
eliminated.
    And second, you should be regulating those derivatives to 
make sure that you don't have a situation where a company is 
essentially betting the bank, saying that if the coin comes up 
heads, then we make a lot of money. If the coin comes up tails, 
then the government bails us out. I mean, that is not a 
situation that we want to have.
    So good regulation of derivatives positions, including 
uncustomized derivatives, would also be part of a new regime.
    Senator Merkley. If I could summarize what you just said, 
you said you support moving to an exchange, and as you put it, 
for all the derivatives that could be standardized. Of course, 
we have the challenge of deciding to what degree derivatives 
can be standardized. We have a lot of end users who are also 
very resistant to the idea of going to an exchange because they 
feel that the margin costs would impede their ability to hedge, 
and that might be an argument that is coming forward regardless 
of the ability to standardize. Any thoughts about that issue?
    Mr. Bernanke. Well, I think the case for exceptions is not 
the margin costs. So that is an appropriate cost of just 
protecting against the counterparty risk. The case for not 
putting everything on the exchange is that some risks are not 
hedgeable through standard derivatives. It could be that I, as 
a municipality, want to hedge against some complicated set of 
events that might occur and there is no way that a derivative 
can be written that would be standardizable that would meet my 
needs. So there are going to be circumstances where derivatives 
are not customizable and they are still providing a useful 
hedging service.
    There are a couple of practical issues that come up there. 
I think one of them is what exemptions do you give on the end 
user side, and I think the main goal there is to avoid getting 
around the regulations through indirect means of setting up 
these deals. For legitimate end users who are nonfinancial 
companies who need to hedge some specific risks, we ought to 
try to make it possible for them to do that.
    But on the other side, if they are transacting, for 
example, with a bank or a dealer, the bank or the dealer should 
face regulations or capital requirements both to make sure that 
they are safe in the positions that they are taking, but also 
to internalize the cost, the potential cost to the system. 
There is a risk associated with these derivatives not traded on 
central counterparties. If the bank knows that it has to hold a 
certain amount of capital against its nonstandardized 
positions, that will increase its effective cost of offering 
those positions and that will, in some sense, balance the 
scales so there is not an artificial incentive to create 
noncustomized derivatives.
    So it is a balancing act, but we do want to leave some 
space for derivatives that are specialized for individual 
needs.
    Senator Merkley. So the challenge of drawing that line 
between what is customized and providing that opportunity, if 
you will, to address it, also, then, the challenge that I think 
this is--I think this is what you are saying, but I will just 
repeat it and make sure I understand--is that you want to have 
appropriate boundaries on that to prevent that exception from 
being something that the entire derivative market is driven 
through.
    Mr. Bernanke. That is right.
    Senator Merkley. And then were you saying that there need 
to be fees based on OTC derivatives as part of that inherent 
risk to the system?
    Mr. Bernanke. Well, not necessarily fees, but to the extent 
that you have nonstandardized OTC derivatives, there should be 
sufficient capital behind them and sufficient oversight of 
their positions so that, A, the institution is not being put 
into mortal danger by its positions that it has taken, and B, 
the extra capital is, in fact, a kind of cost, and that would 
tend to even the playing field between customized and 
noncustomized derivatives.
    Senator Merkley. Mr. Chair, can I put in one more question 
here?
    Chairman Dodd. Yes, quickly. We have got a vote here coming 
up.
    Senator Merkley. A quick question, then. You referred 
earlier to the fact that you didn't feel in the AIG situation 
that you all had much leverage in terms of asking institutions 
to take a haircut. It is a little hard for ordinary Americans 
and some of us, myself included, to get my hands around that, 
because if the risk is that folks might have a tremendous loss, 
it seems like they would be ready to come to the table and say, 
we will mitigate that by taking some share. But let us just say 
that in that crisis, that moment, the need to move fast, that 
wasn't possible. Are there things that we should do in 
structuring this bill that in the future, when that situation 
arises that gives the sort of leverage that would make sense to 
enable the Fed to drive a better deal, if you will?
    Mr. Bernanke. Absolutely. My earlier response, I didn't 
want to convey that we didn't want to get the haircut. We 
really did and we tried. The problem under the existing system 
is that the only way to get the haircut is to have a credible 
threat that, well, if you don't take the haircut, we are going 
to go bankrupt and you are going to lose everything. But, of 
course, since we had intervened to prevent AIG from going 
bankrupt and everybody knew that the collapse of AIG would have 
catastrophic implications for the financial system, it just 
wasn't credible that we would let that happen and so we didn't 
have the leverage.
    So it was a bad outcome, absolutely, I agree, but we really 
didn't have much choice given the legal structure we were in. 
By all means, the reform ought to fix that, and in particular, 
when the government comes in, the Treasury, the FDIC comes in 
to unwind a systemically critical financial firm, it should be 
using a special bankruptcy procedure, not the usual one, a 
special procedure which allows the government to, under perhaps 
some specified rules in advance, to take haircuts, not to 
protect the equity holders, the subordinated debt holders, for 
example, at the same time that you are still having a safe 
wind-down.
    So I think if you structure this resolution authority, one 
of the many benefits of it will be that the government will be 
able to put the cost on the creditors. It will be able to 
renegotiate contracts, including bonuses and things of that 
sort. Those are all the things we needed, but we didn't have in 
the current system.
    Senator Merkley. Thank you. Thank you very much.
    Chairman Dodd. Thank you very much.
    We are going to briefly turn to my colleague from Alabama 
and then have brief closing remarks. But then Senator Corker 
wants to come back and he has a question or two for you, as 
well, Mr. Chairman.
    Senator Shelby. Thank you, Mr. Chairman. I will try to be 
brief, Mr. Chairman.
    Chairman Bernanke, I believe that the last few years have 
provided us with ample evidence to conclude that the current 
regulatory structure that we have, one in which the Fed serves 
as the preeminent regulatory body, requires considerable 
restructuring. In fact, I believe the American people realize 
that. I also believe, too, that the Fed's monetary policy 
independence is crucial and it must be preserved. Very 
important to the central bank.
    Fortunately, the regulatory reform process gives us here, I 
think, a chance to develop a better, more accountable 
regulatory structure and enhance the real and perceived 
independence of the Federal Reserve as a monetary policy 
setting entity. Very important.
    But to achieve these ends, I think the Fed will have to 
give up some of the regulatory authority, as Senator Dodd has 
proposed. I would hope that you, as the Chairman, in the 
interest of achieving better regulation and better monetary 
policy and independence of the Fed, would put the monetary 
policy ahead of your interest, of the Fed's interest, in 
protecting turf.
    Mr. Chairman, I do have, and this is just a short letter 
and I want to share it and I would like it to be made part of 
the record.
    Chairman Dodd. Without objection.
    Senator Shelby. This is a letter in The Washington Post 
today, and some of you have probably read it, but it was 
written by Vincent Reinhart. He is a resident scholar at the 
American Enterprise Institute and it has to do with the 
proposals Chairman Dodd has made.
    It says, ``Regarding Federal Reserve Chairman Ben 
Bernanke's November 29 Sunday Opinion commentary, `The Right 
Reform for the Fed,' '' that you wrote, ``As a result of 
legislative convenience, bureaucratic imperative and historical 
happenstance, a variety of responsibilities have accreted to 
the Fed over the years. In addition to conducting monetary 
policy, the Fed also distributes currency, runs the system 
through which banks transfer funds, supervises financial 
holding companies and some banks, and writes rules to protect 
consumers in financial transactions. Mr. Bernanke argues that 
preserving this melange is not only efficient but crucial to 
protecting the Fed's independence.
    ``Apparently,'' the letter goes on, ``the argument runs, 
there are hidden synergies that make expertise in examining 
banks and writing consumer protection regulations useful in 
setting monetary policy. In fact, collective diverse 
responsibilities in one institution fundamentally violates the 
principle of comparative advantage, akin to asking a plumber to 
check the wiring in your basement.''
    ``There is an easily verifiable test,'' he writes. ``The 
arm of the Fed that sets monetary policy, the Federal Open 
Market Committee, has scrupulously kept transcripts of its 
meetings over the decades,'' and this man writing this says, 
``I should know, I was the FOMC Secretary for a time.'' And 
then, ``After a lag of 5 years, this record is released to the 
public. If the FOMC made materially better decisions because of 
the Fed's role in supervision, there should be instances of 
informed discussion of the linkages. Anyone making the case for 
beneficial spillover should be asked to produce numerous 
relevant excerpts from that historical resource. I don't think 
they will be able to do so.''
    He writes further, ``The biggest threat to the Fed's 
independence is doubt about its competence. The more the 
Congress expects the Fed to do, the more likely will such 
doubts blemish its reputation.''
    I ask that this letter be put in the record.
    Chairman Dodd. Without objection, it will be included.
    Mr. Chairman, Senator Corker will come over and close up 
here, but let me--first of all, I want to thank Senator Shelby 
for his comments about the effort we are making, and I want to 
thank you, as well, and your staff. You have been tremendously 
helpful already and very constructive.
    I was one of those people in that room on the night of 
September 18 when you and Hank Paulson came into the room, and 
there are a lot of people going back, and I will go to my grave 
believing that what you did--what we did--over that 2-week 
period, sort of the economic equivalence almost of 9/11 in ways 
as you described it that evening in a very straightforward, 
monotone voice--I will never forget your words--will go down as 
the right thing to have done. And he is not here now, but Judd 
Gregg, Bob Corker, Jack Reed, Chuck Schumer, on this side, 
anyway, we met along with some others and worked with you and 
others in putting that proposal together. You deserve, in my 
view, a great deal of credit for moving that forward and then 
the creative ideas that kept us out of the difficulty. Proving 
a negative is always hard, and obviously we don't ever want to 
be in a situation to have to prove that. But nevertheless, I 
think we did by the actions that were taken.
    I also want to underscore something Judd said about the 
idea of having something big is bad. I think that is a bad idea 
and we don't include that. I think the idea that you have 
described in how you require capital standards and so forth to 
make sure that you don't have an institution be at risk makes a 
lot of sense, as well.
    And the door is open here. Look, we are very much in the 
process. This is a dynamic process we are engaged in. I 
strongly support your confirmation. And as I said at the 
outset, I believe you are the right person at the right time to 
do this job. But I want you to know the door is open as we are 
trying to evaluate how best to do this.
    I think all of us here very much appreciate this is a 
unique moment we are getting. There have been many others 
before us who have talked about doing this, but there was never 
the will to do it. If there is any silver lining in what we 
have been through, and the fact that we had 52 hearings this 
year on this subject alone in this Committee, it is because we 
are in this moment. If we wait too long, the moment passes. And 
people will say, well, look, things are going well. Why bother? 
If we had acted too early, we might have overreacted, in my 
view, and that would have been bad, as well.
    So we are right in this kind of sweet spot in which I think 
we have a chance, and I believe there is a common determination 
by virtually everybody on this Committee, Democrat and 
Republican, not seeing this ideologically, but what works, what 
doesn't, what is right, what is wrong, and we invite you and 
your staff and others to be at that table with us as we go 
through this, not to suggest that we are going to agree on 
everything, but I want you to know that door is open.
    Senator Shelby. Mr. Chairman, could I say one thing?
    Chairman Dodd. Yes, sir.
    Senator Shelby. I agree with Senator Dodd. I don't think 
big is necessarily bad.
    Chairman Dodd. No.
    Senator Shelby. But I do believe big is bad when it has an 
implicit----
    Chairman Dodd. I agree.
    Senator Shelby. ----response out there with the marketplace 
that the government is backing it.
    Chairman Dodd. I agree with that.
    Senator Shelby. That is bad, Mr. Chairman.
    Mr. Bernanke. I agree, as well.
    Chairman Dodd. We all agree on that.
    Senator Corker, you are----
    Senator Corker. Thank you.
    Chairman Dodd. I am going to go over and vote. You are in 
charge.
    Senator Corker. When you come back, you will never know 
what may have happened to this place.
    [Laughter.]
    Senator Corker. But I will try to behave like a gentleman, 
sir.
    Chairman Dodd. Thank you, Mr. Chairman.
    Mr. Bernanke. Thank you.
    Senator Corker [presiding]. Mr. Chairman, I thank you for 
being with us so long, and I think you know that I was happy 
that the administration decided to renominate you. And I think 
you knew coming into these confirmations, unless something 
really strange happened, that I was going to support you, and I 
am. OK?
    I am becoming slightly frustrated, though, and I know that 
you are probably going to be confirmed, and I do not know when 
that is going to happen. You know, it may be held off until 
after reg reform occurs, as I mentioned to you the other day on 
the phone. It may happen before. You are the Fed Chairman 
regardless. I mean, I think you are the Fed Chairman until 
another Fed Chairman is nominated and approved, and I think 
that is the case. Your staff is nodding no, but that is 
debatable, I guess.
    But I have worked very closely with you over the last year, 
which I appreciate, or year and a half. And we have talked 
about a lot of things important to our country. And what I have 
appreciated about you is I absolutely do not believe you have a 
political cell in your body, as I have said publicly many 
times, and I really believe you wake up every day trying to do 
what you think is best for our country.
    But I am concerned--and I am becoming sort of frustrated 
with it--that the activity--I mean, you have worked very 
closely with both administrations. This is not partisan. I 
think much of that has hurt your credibility some. And just as 
you mentioned, as we talked earlier in our last exchange, on 
the fiscal side I do think that you end up getting used as a 
tool for administrations to advance policies that they think is 
good, it is outside the monetary policy issue. And I just would 
caution you, I think that hurts you. OK?
    The Bush, the stimulus was ridiculous. I mean, it was 
silly. It was sophomoric, and it had no effect, and you 
supported it. And when you support it, I mean, what happens on 
the Senate floor when Ben Bernanke says that he supports 
something, because of the respect not only of you but the 
position, that has an effect. Same thing with the Obama 
stimulus, which, you know, regardless of what people say, it 
did not accomplish what they said it would do, and I think it 
was certainly less than a stimulus. And we can debate that. It 
does not really matter. That is not what matters. What matters 
to me is that you weighed in, and when you weigh in on 
something, it is like it gets the Moody's rating--not that 
Moody's rating matters much anymore. But that is what it does.
    I think the same thing is happening right now in financial 
regulation. And as I said way back when, long before this, 6 to 
8 months ago, at maybe the last Humphrey Hawkins meeting, I 
think to the extent that the Fed continues to thrust itself in 
the middle of things, you know, being the systemic regulator, 
which, again, we are going to have another systemic risk, we 
are going to have another failure, we are going to have--I do 
not care who the Fed Chairman is. I do not care what kind of 
reg bill we pass. It is going to happen. And it just seems to 
me that the more you thrust yourself in the middle of those 
things that are outside of monetary policy and outside of being 
lender of last resort, the more you do things to damage the 
institution.
    And I say that because I respect the institution, and just 
like Judd Gregg said and just like I think I said in my 
comments, I do not want us involve in monetary policy. I think 
that would be a disaster not only for our country, but for 
every country that does business with us, which is every 
country.
    So I am becoming--you know, I know you are lobbying us 
heavily right now as far as what the Fed role should be in 
regulation. And on a private basis, I want to hear that. I 
mean, just a minute ago, I know that you alluded to Chairman 
Dodd's bill, and I have to tell you--and everyone on his staff 
knows this--I very much appreciate what he is doing to try to 
work out a bipartisan bill, and I think we are going to do 
that. At least I am going to keep saying I think we are going 
to do that until I think we are not, OK? But just like, for 
instance, saying a minute ago that you think this bill 
absolutely solves too big to fail. Well, at least that is what 
was reported to me, and I----
    Mr. Bernanke. No, I----
    Senator Corker. Please clarify that, because as much as I 
respect him, I think there are some frailties in the 
legislation.
    Mr. Bernanke. I only talked about some general elements. I 
certainly did not endorse the bill.
    Senator Corker. Good. I got an e-mail in another meeting, 
and I am glad--well, I just think that you are highly 
respected, the position is highly respected. I think the more 
the Fed throws itself in the middle of things that are outside 
the categories that it is charged to do, the chances are--maybe 
not you but the next person down the road--the Fed's 
independence ends up being undermined. And there is no question 
to me that the efforts by Congressman Paul and others to do the 
things that are occurring right now, I know his longer-term 
goal is--I understand he is a gold standard person. I 
understand there are other goals behind that. But I do think 
that much of what has happened recently and the hyperactivity 
of some of 13.3 issues, with Maiden Lane and AIG, I mean, you 
know, that is kind of questions. It ended up sort of being 
equity, and I do not mean that, again, to poke jabs, but that 
type of activity ends up hurting the Fed, an institution that, 
like Judd Gregg and others, I respect, you I respect. And I 
guess over the last 45 days or so, I have become very nervous 
about that activity. And I just want to tell you that. And I am 
nervous about us and what we might do, but I am also beginning 
to be nervous about the powers that you at the Fed want to take 
on, that Treasury is encouraging you to take on, and I just 
wondered if you might respond to that knowing that I am 
somebody who, unless the sky falls in, I am going to support 
your nomination. And I respect your abilities and intellect, 
and I appreciate what you have tried to do on behalf of our 
country. But I am concerned about what that is actually doing 
to the Fed itself.
    I do not now if you are understanding. I do not know if I 
am expressing myself well.
    Mr. Bernanke. You expressed yourself well, Senator. I would 
like to respond briefly, if I could. First of all, I thank you 
for the conversations we have had. It has been very good to 
work with you.
    First, your point on fiscal policy, I have tried to stay 
out of fiscal policy. I will be more vigilant in the future. I 
think there is an appropriate division of labor: Congress and 
the administration, fiscal policy; Federal Reserve, monetary 
policy. And I will try to do that, although I should say that I 
think there are some broad general issues like the deficit, for 
example, where the Federal Reserve Chairman does have some 
responsibility to speak up, and I think I will have to continue 
to do that.
    Senator Corker. And I am speaking more to specific policy 
proposals.
    Mr. Bernanke. Right.
    Senator Corker. And I think----
    Mr. Bernanke. Well, even in the cases you cite, I never 
said anything more than maybe it is time to think about this 
general thing. I never endorsed any particular plan. I never 
endorsed any components of it or any size or anything like 
that. But I take your point.
    Second, some of the steps we have taken, like the AIG 
episode, for example, obviously have hurt the Fed a lot 
politically. We know that. And I think that should just be 
proof that we did it for the good of the country. We did not do 
it for ourselves, because it obviously has hurt the Federal 
Reserve in the public's view. We did it because we felt that 
there was no other way to avoid what a number of your 
colleagues have called the risk of a catastrophic collapse of 
the financial system. And so we did what we did knowing it 
would be politically unpopular, knowing it would bring down 
problems for the Federal Reserve, but because we did not have 
an alternative. And one of the things we are hoping, of course, 
that the Congress will come up with will be some framework that 
will allow this to be done in a more orderly way and will leave 
the Federal Reserve completely out of it. And we would like to 
be left out of it.
    On financial stability, I would like to differ just a 
little bit, which is that the Federal Reserve actually was 
founded in 1913 for financial stability purposes, not monetary 
policy, and it has been a big part of financial stability for 
100 years almost. We have not been lobbying. What we have been 
doing, if anything, is trying to provide advice and our 
reasoned views on the subject. And what some might think of as 
turf in my view is an important component of thinking about how 
a successful financial stability program ought to be 
structured.
    So given that that is very much in our domain, I do not 
want to use undue influence, but to the extent that we have 
arguments and positions to take, I only ask you to believe that 
we do it based on what our view is of the appropriate public 
policy and not because of turf. And you will notice that we 
have not used the same kind of energy on some other aspects, 
that this has been the thing which we view as critical, and I 
actually do believe that if the Federal Reserve is completely 
eliminated from financial stability policy, it will have very 
negative consequences at some time in the future when neither 
you nor I may be here.
    So I hope you will understand that on that particular issue 
we do feel we have a stake and an expertise and that we are 
trying just to get the right policy.
    Senator Corker. Well, I appreciate that, and I also 
apologize for being given some information about the hearing a 
minute ago that apparently was off base, and certainly I am 
very glad you cleared that up. And I would just echo the same 
thing that Chairman Dodd just said, and that is, I think that 
we, all of us here, just are trying to get it right, and I 
think it is really hard. I think the resolution piece and the 
too-big-to-fail piece is the most important. If we do nothing 
else over the course of the next several months but solve that, 
I think it is the most important thing, and in my opinion, if 
we only did that, that would be fine.
    I hope that you will, you know, continue to talk with us in 
our offices, both privately and in any other setting, to help 
us work through this. And my comments today, again, are not in 
any way to--they are just to say that, look, my antenna right 
now makes me feel nervous about the hyperactivity and the 
unintended consequences of what could happen down the road. I 
mean, you responded aggressively during this last cycle, and as 
has been said, you know, you are being criticized for 
responding aggressively. And I think if we allow the Fed's role 
in our financial system to become something far greater than it 
should be--there is an appropriate level, I understand--but far 
greater than it should be, we are going to set ourselves up to 
do some ultimate longer-term damage to our country.
    Anyway, thank you for letting me talk with you. I know all 
of us could Monday morning quarterback the many zillion calls 
that you have had to make over the last year or so, and with 
little information and little time. I respect you for what you 
are doing. I thank you for coming and being so patient with us 
today, and I do look forward to over the next couple months 
with Chairman Dodd's staff and Ranking Member Shelby's staff 
and all of us working together to try to get it right, and I 
thank you.
    Mr. Bernanke. Thank you.
    [Whereupon, at 3:13 p.m., the hearing was adjourned.]
    [Prepared statements, biographical sketch of nominee, 
responses to written questions, and additional material 
supplied for the record follow:]

               PREPARED STATEMENT OF SENATOR TIM JOHNSON
    Thank you Chairman Dodd and Ranking Member Shelby for holding the 
nomination hearing for Ben Bernanke to serve another term as Chairman 
of the Federal Reserve Board of Governors. This will be one of the most 
important nomination hearings the Banking Committee will hold all year, 
as the Administration and Congress continue to look for ways to restore 
our Nation's financial stability, promote economic recovery, and work 
on legislation to ensure that another economic crisis like the one we 
faced last year never happens again.
    While there has certainly been criticism of the Federal Reserve for 
not doing enough to protect consumers and for the unprecedented actions 
it took during the financial crisis, there is also consensus that Mr. 
Bernanke kept our Nation out of a Depression and has kept inflation in 
check. As our Nation recovers, and faces additional challenges in the 
months ahead, there is no doubt that having one of the world's foremost 
experts on the Great Depression at the helm of the Federal Reserve is a 
benefit to our Nation as a whole.
    As it is the Fed's independence and its ability to carry out day-
to-day decisions about monetary policy without the intrusion of 
Congress that strengthens the Fed's credibility in the eyes of the 
private sector and allows it to follow policies that maximize price 
stability and economic stability, I do question what other 
responsibilities the Fed should have. Should the Fed supervise the 
biggest banks? Were the stress tests effective? Has the Fed constrained 
excessive risk-taking in the financial sector? Has the Fed done enough 
since the crisis to improve its oversight of bank holding companies and 
to be able to predict and prevent the next crisis? Does the Fed have 
too much power and responsibility and should Congress designate some of 
the Fed's obligations to other agencies? These are all questions that 
this Committee must consider in the coming weeks with regulatory reform 
legislation. Finding the right answers to these questions is important 
to our Nation's economic stability.
    All this said, the Fed has economic and financial expertise that is 
unrivaled, and I believe that Mr. Bernanke has rightly been renominated 
for this post. I look forward to the opportunity to hear Mr. Bernanke's 
testimony, and to hear his responses to my questions and my colleagues' 
questions.
                                 ______
                                 

                 PREPARED STATEMENT OF BEN S. BERNANKE
                            To Be Chairman,
           Board of Governors of the Federal Reserve System,
                            December 3, 2009
    Chairman Dodd, Senator Shelby, and Members of the Committee, I 
thank you for the opportunity to appear before you today. I would also 
like to express my gratitude to President Obama for nominating me to a 
second term as Chairman of the Board of Governors of the Federal 
Reserve System and for his support for a strong and independent Federal 
Reserve. Finally, I thank my colleagues throughout the Federal Reserve 
System for the remarkable resourcefulness, dedication, and stamina they 
have demonstrated over the past 2 years under extremely trying 
conditions. They have never lost sight of the importance of the work of 
the Federal Reserve for the economic well-being of all Americans.
    Over the past 2 years, our Nation, indeed the world, has endured 
the most severe financial crisis since the Great Depression, a crisis 
which in turn triggered a sharp contraction in global economic 
activity. Today, most indicators suggest that financial markets are 
stabilizing and that the economy is emerging from the recession. Yet 
our task is far from complete. Far too many Americans are without jobs, 
and unemployment could remain high for some time even if, as we 
anticipate, moderate economic growth continues. The Federal Reserve 
remains committed to its mission to help restore prosperity and to 
stimulate job creation while preserving price stability. If I am 
confirmed, I will work to the utmost of my abilities in the pursuit of 
those objectives.
    As severe as the effects of the crisis have been, however, the 
outcome could have been markedly worse without the strong actions taken 
by the Congress, the Treasury Department, the Federal Reserve, the 
Federal Deposit Insurance Corporation, and other authorities both here 
and abroad. For our part, the Federal Reserve cut interest rates early 
and aggressively, reducing our target for the Federal funds rate to 
nearly zero. We played a central role in efforts to quell the financial 
turmoil, for example, through our joint efforts with other agencies and 
foreign authorities to avert a collapse of the global banking system 
last fall; by ensuring financial institutions adequate access to short-
term funding when private funding sources dried up; and through our 
leadership of the comprehensive assessment of large U.S. banks 
conducted this past spring, an exercise that significantly increased 
public confidence in the banking system. We also created targeted 
lending programs that have helped to restart the flow of credit in a 
number of critical markets, including the commercial paper market and 
the market for securities backed by loans to households and small 
businesses. Indeed, we estimate that one of the targeted programs--the 
Term Asset-Backed Securities Loan Facility--has thus far helped finance 
3.3 million loans to households (excluding credit card accounts), more 
than 100 million credit card accounts, 480,000 loans to small 
businesses, and 100,000 loans to larger businesses. And our purchases 
of longer-term securities have provided support to private credit 
markets and helped to reduce longer-term interest rates, such as 
mortgage rates. Taken together, the Federal Reserve's actions have 
contributed substantially to the significant improvement in financial 
conditions and to what now appear to be the beginnings of a turnaround 
in both the U.S. and foreign economies.
    Having acted promptly and forcefully to confront the financial 
crisis and its economic consequences, we are also keenly aware that, to 
ensure longer-term economic stability, we must be prepared to withdraw 
the extraordinary policy support in a smooth and timely way as markets 
and the economy recover. We are confident that we have the necessary 
tools to do so. However, as is always the case, even when the monetary 
policy tools employed are conventional, determining the appropriate 
time and pace for the withdrawal of stimulus will require careful 
analysis and judgment. My colleagues on the Federal Open Market 
Committee and I are committed to implementing our exit strategy in a 
manner that both supports job creation and fosters continued price 
stability.
    A financial crisis of the severity we have experienced must prompt 
financial institutions and regulators alike to undertake unsparing 
self-assessments of their past performance. At the Federal Reserve, we 
have been actively engaged in identifying and implementing improvements 
in our regulation and supervision of financial firms. In the realm of 
consumer protection, during the past 3 years, we have comprehensively 
overhauled regulations aimed at ensuring fair treatment of mortgage 
borrowers and credit card users, among numerous other initiatives. To 
promote safety and soundness, we continue to work with other domestic 
and foreign supervisors to require stronger capital, liquidity, and 
risk management at banking organizations, while also taking steps to 
ensure that compensation packages do not provide incentives for 
excessive risk-taking and an undue focus on short-term results. Drawing 
on our experience in leading the recent comprehensive assessment of 19 
of the largest U.S. banks, we are expanding and improving our cross-
firm, or horizontal, reviews of large institutions, which will afford 
us greater insight into industry practices and possible emerging risks. 
To complement on-site supervisory reviews, we are also creating an 
enhanced quantitative surveillance program that will make use of the 
skills not only of supervisors, but also of economists, specialists in 
financial markets, and other experts within the Federal Reserve. We are 
requiring large firms to provide supervisors with more detailed and 
timely information on risk positions, operating performance, and other 
key indicators, and we are strengthening consolidated supervision to 
better capture the firmwide risks faced by complex organizations. In 
sum, heeding the lessons of the crisis, we are committed to taking a 
more proactive and comprehensive approach to oversight to ensure that 
emerging problems are identified early and met with prompt and 
effective supervisory responses.
    We also have renewed and strengthened our longstanding commitment 
to transparency and accountability. In the making of monetary policy, 
the Federal Reserve is highly transparent, providing detailed minutes 3 
weeks after each policy meeting, quarterly economic projections, 
regular testimonies to the Congress, and much other information. Our 
financial statements are public and audited by an outside accounting 
firm, we publish our balance sheet weekly, and we provide extensive 
information through monthly reports and on our Web site on all the 
temporary lending facilities developed during the crisis, including the 
collateral that we take. Further, our financial activities are subject 
to review by an independent inspector general. And the Congress, 
through the Government Accountability Office, can and does audit all 
parts of operations, except for monetary policy and related areas 
explicitly exempted by a 1978 provision passed by the Congress. The 
Congress created that exemption to protect monetary policy from short-
term political pressures and thereby to support our ability to 
effectively pursue our mandated objectives of maximum employment and 
price stability.
    In navigating through the crisis, the Federal Reserve has been 
greatly aided by the regional structure established by the Congress 
when it created the Federal Reserve in 1913. The more than 270 business 
people, bankers, nonprofit executives, academics, and community, 
agricultural, and labor leaders who serve on the boards of the 12 
Reserve Banks and their 24 Branches provide valuable insights into 
current economic and financial conditions that statistics cannot. Thus, 
the structure of the Federal Reserve ensures that our policymaking is 
informed not just by a Washington perspective, or a Wall Street 
perspective, but also a Main Street perspective.
    If confirmed, I look forward to working closely with this Committee 
and the Congress to achieve fundamental reform of our system of 
financial regulation and stronger, more effective supervision. It would 
be a tragedy if, after all the hardships that Americans have endured 
during the past 2 years, our Nation failed to take the steps necessary 
to prevent a recurrence of a crisis of the magnitude we have recently 
confronted. And, as we move forward, we must take care that the Federal 
Reserve remains effective and independent, with the capacity to foster 
financial stability and to support a return to prosperity and economic 
opportunity in a context of price stability.
    Thank you again for the opportunity to appear before you today. I 
would be happy to respond to your questions.



        RESPONSES TO WRITTEN QUESTIONS OF SENATOR SHELBY
                      FROM BEN S. BERNANKE

Q.1. With respect to the failure of Lehman Brothers, you stated 
in a speech delivered on August 21 of this year that: ``As the 
Federal Reserve cannot make an unsecured loan, and as the 
government as a whole lacked appropriate resolution authority 
or the ability to inject capital, the firm's failure was, 
unfortunately, unavoidable.'' However, in the case of American 
International Group (AIG), it was judged that the firm had 
assets that were adequate to secure an $85 billion line of 
credit. Would the Chairman provide any documents prepared by 
the Fed detailing or analyzing the adequacy of collateral in 
the case of Lehman Brothers and in the case of AIG?

A.1. We are working with your staff and Committee staff to 
respond to requests for documents, which include information 
related to valuations of the assets that are collateral for the 
extensions of credit to AIG or related to AIG assets.

Q.2. Former New York Insurance Commissioner Eric Dinallo has 
testified that ``the crisis for AIG did not come from its State 
regulated insurance companies.'' Does the Federal Reserve 
agree?

A.2. Many factors contributed to the imminent liquidity crisis 
that faced AIG in the fall of 2008. Among these factors were 
limitations on the authority of the State insurance 
commissioners to monitor and regulate significant risks that 
were taken by AIG (the parent holding company) and its 
unregulated subsidiaries, in particular AIG Financial Products. 
These risks imperiled the entire organization and, because of 
the scope, size, and interconnectedness of AIG, the financial 
system. A disorderly failure of AIG clearly would have placed 
additional pressures on, and magnified the risks facing, AIG's 
insurance subsidiaries, as well as financial markets and 
financial institutions generally. The resulting uncertainty 
could have led to a run by policyholders and creditors on the 
insurance industry as a whole.

Q.3. Former New York Insurance Commissioner Eric Dinallo has 
testified that ``AIG life insurance companies would not have 
been insolvent'' because of losses related to AIG's securities 
lending program. Does the Federal Reserve agree?

A.3. As the functional regulator of the New York-domiciled 
insurance subsidiaries of AIG, former Commissioner Dinallo 
would have been in the best position to determine whether the 
losses incurred as a result of AIG's securities lending program 
would have caused the New York-domiciled insurance subsidiaries 
to be insolvent under State insurance law and regulations. 
However, the securities lending program did create risks for 
the AIG organization and increased the liquidity pressures on 
AIG for the reasons noted above and in my previous testimonies. 
In addition, AIG's insurance subsidiaries had substantial 
derivatives exposures to AIG Financial Products and were 
interconnected with the parent company and its unregulated 
affiliates in a variety of operational and other ways. The 
failure of AIG during the period of severe financial and 
economic stress in the autumn of 2008 would have had severe 
consequences on AIG's insurance subsidiaries and the financial 
system.

Q.4. It is often mentioned that large systemically important 
firms should face higher capital, liquidity, or other 
requirements to reflect risks that they pose to the system. How 
exactly could the systemic risks be measured and the special 
requirements be tailored to effectively internalize systemic 
externalities that might arise from such firms? If it had the 
authority, would the Federal Reserve impose any special 
systemic-risk-based requirements on any institution that it 
oversees today?

A.4. One of the clear lessons of the crisis is that the 
capital, liquidity and risk-management requirements for large, 
interconnected firms need to be strengthened both to improve 
the safety and soundness of the individual institutions and to 
reflect the risks that these organizations pose to the 
financial system as a whole. As I have noted in speeches and 
testimonies, we are in the process of strengthening the 
prudential standards for the large financial institutions we 
supervise, working in collaboration with relevant domestic and 
foreign supervisors, and of adjusting our supervisory practices 
to take greater account of macroprudential considerations. The 
best methods of measurement and implementation of standards 
based on the systemic importance of organizations are still 
being worked out, and will likely require that regulators 
collect additional data from firms, but the need for heightened 
standards for systemically important institutions remains 
clear.

Q.5. In September 2008, the Treasury created a new 
``supplemental financing account,'' which, at its inception, 
held $500 billion obtained by the Treasury from selling a 
special issue of Treasury bills to the public. What was the 
reason for this large injection of funds by the Treasury into 
the Federal Reserve? Did the Federal Reserve ask the Treasury 
to establish a new supplemental financing account?

A.5. In September 2008, the Federal Reserve requested that the 
Treasury establish a Supplementary Financing Program (SFP) to 
help the Federal Reserve manage the balance sheet effects of 
the credit and liquidity initiatives that the Federal Reserve 
had undertaken to address severe strains in financial markets. 
Specifically, the SFP has facilitated the Federal Reserve's 
implementation of monetary policy by enhancing its control over 
the supply of bank reserves.
                                ------                                


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

Q.1. Section 109 of the recently enacted ``Credit Card 
Accountability Responsibility and Disclosure Act of 2009'' 
rightly requires card issuers to consider the ability of a 
consumer to make required payments on an account before opening 
the account or increasing an existing line of credit. Recently, 
the Fed released its proposed regulations to implement Section 
109. Can you describe the process undergone by the Board in 
writing the proposed regulations to implement Section 109? What 
considerations were made when the Board decided to further 
define the ``the ability of a consumer to make required 
payments''? Can you please describe the benefits associated 
with consideration of income instead of consideration of 
``ability to pay''? Can you also describe to the Committee the 
benefits associated with the consideration of a consumer's 
income or assets in connection with a credit card loan and 
compare them to the potential operational and other costs 
associated with such a requirement, such as reduced credit 
availability? Do you think your rule for Section 109 
appropriately weighs the costs and benefits of this change?
A.1. Our implementation of the Credit Card Accountability, 
Responsibility and Disclosure Act of 2009 (``CARD Act'') 
followed the process used by the Board in other rulemakings. 
After reviewing the statutory language and legislative history 
of the Act, including Section 109, we conducted outreach 
meetings with both industry representatives and consumer groups 
to inform our judgments about the best way to implement the 
statute. We also drew on our recent experience in developing 
mortgage regulations that require creditors to consider 
consumers' ability to make the scheduled loan payments. We are 
currently in the process of considering the comments received 
on the proposed rules in order to develop final rules.
    Section 109 requires card issuers to consider a consumer's 
ability to make the required payments under the terms of the 
account before opening the account or increasing an existing 
credit limit. Under the Board's proposal, a card issuer must, 
at a minimum, consider the consumer's ability to make the 
required minimum periodic payments after reviewing the 
consumer's income or assets as well as the consumer's current 
obligations. The proposed rules specify, however, that card 
issuers may also consider other factors traditionally used by 
the industry in determining creditworthiness, such as the 
consumer's payment history, credit report, or credit score. 
These additional factors provide creditors with useful 
information about a consumer's past propensity to pay. As we 
develop the final rule, the Board will carefully consider the 
public comments and weigh the operational and other burdens 
created by the rule against the potential benefits to 
consumers.
                                ------                                


         RESPONSES TO WRITTEN QUESTIONS OF SENATOR BAYH
                      FROM BEN S. BERNANKE

Q.1. The United States Mint recently issued a report that 
concluded that its State Quarters Program--honoring each State 
with a quarter bearing symbols emblematic of that State on its 
reverse side--had realized $6.3 billion dollars in profit to 
the government from seigniorage. [Seigniorage occurs when coins 
are taken out of circulation by collectors and the government 
realizes the difference between the coin's face value and the 
per unit production cost--a profit of more than 23 cents per 
quarter.]
    This profit was realized because the Federal Reserve 
provided adequate supplies of each new quarter to its member 
banks so that the public could easily obtain and collect those 
coins. Because of diminished demand during the recession, the 
Fed has reduced the volume of their purchases from the Mint. 
But, more importantly, the Fed has also refused to make coins 
available by design. In other words, they will not allow member 
banks to order specific coins (such as the Guam quarter) to 
make them available to their customers. This combination of 
policies has greatly reduced the availability of individual 
coins to the collecting public.
    A new series honoring the Nation's national parks will 
begin in 2010. If the Federal Reserve continues its policies, 
it will reduce the availability of these new quarters to 
everyday collectors. This in turn will jeopardize the potential 
profit to the government, resulting in nowhere near the $6.3 
billion generated for the Treasury by its predecessor, the 
State quarter.
    While it is the U.S. Treasury that reaps the benefits of 
seigniorage, not the Federal Reserve, the Fed is in a position 
to greatly improve the profit that can be realized by the 
government for the new national parks quarters to be released 
in 2010. Would the Fed consider making each of these coins 
available by design for an initial period after their release? 
In this way, the public would have the ability to obtain and 
collect these coins from circulation, providing much greater 
distribution than will be achieved by the Mint alone.
A.1. The Federal Reserve has supported the previous 
commemorative circulating coin programs that Congress has 
created and will support future programs, including the new 
national parks quarters program that begins next year. The 
method of providing such support, however, requires a careful 
balancing of costs and benefits, with a focus on inventory 
management. At present, the Reserve Banks have sufficient 
inventories of quarters to meet banking industry demand for 
about 3 years. Because of these inventory levels, which are 
very high by historical standards, the Reserve Banks will 
likely not be ordering large quantities of each of the new 
quarter designs. That said, as was done with the Westward 
Journey nickel series, the Abraham Lincoln Bicentennial 
pennies, and the State Quarters program, the Reserve Banks will 
override their normal first-in first-out process, and will 
provide to depository institutions new-design quarters until 
those supplies are exhausted before fulfilling remaining demand 
using other available inventory.
                                ------                                


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

Q.1. The measures you have taken to put the financial system 
back on track have left a handful of banks larger than they 
were prior to the crisis, and those banks are still unwilling 
to lend money, and apparently still engaging in some of the 
same risky investing behavior that led to the mess we're in. If 
they were too big to fail this time around, they will be even 
bigger in the event of a future calamity. The current situation 
only encourages reckless speculation by the major banks who 
have been assured that they will never be held accountable for 
their actions. What will you do to reduce the incentives of 
these banks to engage in reckless behavior if they think 
taxpayers will always bail them out?

A.1. The belief by market participants that some firms may be 
too big to fail has many undesirable effects. A critical first 
step to counteracting the moral hazard problem to which you 
refer is to ensure that all systemically important institutions 
are subject to effective consolidated supervision. Second, a 
more macroprudential approach needs to be incorporated into the 
existing framework for supervision and regulation. A 
macroprudential approach would consider the interdependencies 
among firms and markets that could threaten the financial 
system and the real economy. Such an approach would lead to 
strengthened capital, liquidity, and risk-management 
requirements for systemically important firms. Another 
important step to counteracting moral hazard is to create a 
resolution process that would allow the government to wind down 
in an orderly way a systemically important firm the disorderly 
failure of which would impose substantial costs. Importantly, 
the process should allow the government to impose ``haircuts'' 
on certain creditors and shareholders of such firms.

Q.2. Banking supervision, consumer protection, and monetary 
policy are all very different jobs. There is a real danger that 
all of these important functions could detract from one another 
if they are all given to the Fed. Given the Fed's many 
significant monetary policy responsibilities, can the Fed 
really take on significant responsibilities in other areas as 
well, such as supervision of all systemically significant 
institutions, even those that are not banks? Or more consumer 
protection authority than it has now?
A.2. Many independent agencies within the U.S. government have 
two or more missions or goals. The Federal Reserve believes 
that it can effectively conduct monetary policy, 
macroprudential regulation, and consumer protection and, 
indeed, that there are valuable synergies among these 
responsibilities.
    The conduct of monetary policy and macroprudential 
regulation share important similarities. Both are addressed at 
conditions in the overall economy and financial system. Partly 
for this reason, the two endeavors overlap in terms of relevant 
data and analytical techniques, as well as the necessary staff 
expertise. Over the past 2 years, supervisory expertise and 
information have helped the Federal Reserve to better 
understand the emerging pressures on financial firms and 
markets and to use monetary policy and other tools to respond 
to those pressures. Conversely, the Federal Reserve economists 
primarily employed to support monetary policy contributed 
importantly to the success of the Supervisory Capital 
Assessment Program. The Federal Reserve also views consumer 
protection as complementary to, rather than in conflict with, 
its other central bank responsibilities, such as prudential 
supervision and fostering financial stability. For example, 
sound underwriting benefits consumers as well as lenders, and 
strong consumer protections can add certainty to the markets 
and reduce risks to financial institutions.

Q.3. The Fed has not succeeded on many consumer protection 
fronts, most notably in failing to regulate mortgages. Since 
1994, the Fed has had the power--indeed the duty--under the 
Home Ownership and Equity Protection Act to prohibit loans that 
are ``unfair, deceptive,'' or ``otherwise not in the interest 
of the borrower.'' This sweeping power could have curtailed 
many of the abusive and predatory mortgage lending tactics that 
triggered a massive wave of foreclosures on subprime and Alt-A 
mortgages, but it was not invoked until 2008, long after the 
foreclosure crisis became apparent.
    When did you first encourage the Board of Governors to 
invoke this law?
    Has the Board of Governors conducted any assessment of its 
failure to invoke the law before it did?
    Why should we believe that the Fed will exhibit a better 
track record on consumer protection than it has in the past? 
Shouldn't we give those responsibilities to an independent 
Consumer Financial Protection Agency that is focused on 
protecting American consumers as its primary mission?
    In the wake of the Fed's failure to act in this crucial 
area, why has the Fed remained neutral when it comes to the 
creation of a Consumer Financial Protection Agency?

A.3. In the past several years, the Board has taken several 
actions under the Home Ownership and Equity Protection Act 
(HOEPA) to respond to various consumer protection concerns that 
have arisen in the mortgage marketplace since HOEPA was enacted 
in 1994.
    The Federal Reserve initially published rules to implement 
HOEPA in 1995. In response to the increase in the number of 
subprime loans, the Board held a series of public hearings in 
2000, focused on the abusive lending practices occurring at 
that time and the need for additional rules. The information 
surfaced at those hearings formed the basis for the revision to 
the HOEPA rules issued by the Board in December 2001, which 
strengthened consumer protection, applied HOEPA's protections 
to a larger number of high-cost loans, and addressed practices 
occurring in the market place at that time.
    The 2001 rules also strengthened HOEPA's prohibition on 
unaffordable lending by requiring that creditors generally 
document and verify consumers' ability to repay a high-cost 
HOEPA loan. In addition, the Board used the rulemaking 
authority in HOEPA to prohibit practices that are unfair, 
deceptive, or associated with abusive lending. Specifically, to 
address concerns about ``loan flipping,'' the Board prohibited 
HOEPA lenders from refinancing one high-cost loan with another 
high-cost loan within the first year unless the refinancing is 
in the borrower's interest. The 2001 final rules also addressed 
other issues, such as concerns about costly credit insurance.
    During the summer of 2006, shortly after I became Chairman, 
the Board conducted a series of public hearings to gather 
information about new lending practices that had emerged as the 
subprime market continued to grow. In response, in 2007, the 
Board and other Federal financial regulatory agencies published 
interagency guidance addressing certain risks and emerging 
issues relating to subprime mortgage lending practices, 
particularly adjustable-rate mortgages. The agencies recognized 
that issuing guidance was the swiftest way to respond to these 
concerns. Also in 2007, the Board held another hearing to 
consider ways in which the Board might use its HOEPA rulemaking 
authority to further curb abuses in the home mortgage market, 
including the subprime sector. This became the basis for the 
new HOEPA rules that the Board proposed in December 2007 and 
finalized in July 2008.
    While we should have taken some actions sooner, I believe 
that the Federal Reserve has shown that it can write strong, 
effective consumer regulations, as we have done for both credit 
cards and mortgages. In addition, we recently announced an 
examination program for nonbank subsidiaries of bank holding 
companies. We are strongly committed to the importance of 
consumer protection in maintaining financial stability and 
restoring consumer confidence.
                                ------                                


       RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
                      FROM BEN S. BERNANKE

Q.1. Regulatory Approach--When people think of the Federal 
Reserve, they usually think of monetary policy. But under the 
system we have today, the Fed holds a central position in our 
bank regulatory system and is being asked by the Administration 
and the House of Representatives to hold a larger position. The 
Federal Reserve made a series of decisions that led directly to 
this crisis, including:

    Refusing to provide basic consumer protections on 
        mortgages;

    Fighting regulation of the over-the-counter 
        derivatives market;

    Permitting regulated banks to use off-balance sheet 
        vehicles to hold large amounts of assets;

    Permitting overreliance on short-term funding 
        market (``repo'');

    Driving the development of risk-based capital, 
        first Basel I which was too reliant on rating agencies 
        and then Basel II, which the SEC applied to the 
        investment banks and outsourced to the banks the 
        evaluation of their own capital adequacy; and

    Permitting the rise of unregulated highly complex 
        securitization--CDOs and CDO squareds--which when 
        combined with Basel I, were used by banks to game 
        regulatory capital.

    Certainly not all of these were your decisions, but you 
were on the Board for a substantial period of the time while 
these decisions were made and in 2006, just before this very 
crisis, you spoke on record in favor of many of these 
regulatory approaches. Has your regulatory philosophy 
fundamentally changed because of this crisis, and if so, how?

A.1. The crisis has reinforced some elements of my regulatory 
philosophy and changed others. I have long believed that, 
because of their access to the safety net, bank holding 
companies are not subject to effective market discipline and 
therefore need robust consolidated supervision. The financial 
crisis has demonstrated that, because they may be perceived as 
too big to fail, very large complex nonbank financial 
institutions must also be subject to robust consolidated 
supervision. Furthermore, the crisis has made clear to me that 
consolidated supervision needs to take into account 
macroprudential as well as microprudential considerations. 
Finally, the crisis has convinced me that we must take steps to 
enhance market discipline on large banks and nonbank financial 
institutions. The critical step in that regard is to create 
authority for resolving such firms that carries with it a 
credible threat that their creditors will bear significant 
losses in the event the firm becomes insolvent.

Q.2. Systemic Risk--Proprietary Trading--Even as this economic 
crisis only begins to abate, I am particularly concerned that 
certain large banks engage in a substantial amount of 
proprietary trading even though they are guaranteed by the 
Federal safety net. Even though banks are making billions 
trading on own accounts, it only takes a day or two of large 
losses to cause a failure. Moreover, I continue to hear about 
serious conflicts of interest between banks as client-oriented 
broker-dealers and hedge fund-like principal investors.
    I am pleased that Chairman Dodd's discussion draft includes 
a vigorous GAO study on this issue, but we need to get ahead of 
the curve. What is to prevent another Long-Term Capital 
Management or Barings, where a large bank's trading positions 
get it jammed by an unexpected turn in the market?
A.2. ``Proprietary trading'' or a banking organization's active 
trading and position taking in financial instruments for its 
own account occurs in several forms. In the normal course of 
making markets to meet customers' needs for financial assets 
and liabilities, banking organizations must maintain 
inventories of securities that may or may not be hedged. As a 
result, a certain amount of inventory position taking is 
inherent in the investment banking and market-making business. 
Banks may also take positions above the levels required for 
market-making activity with the hope of generating additional 
income. When such positions occur within the same accounts used 
for customer accommodation, it can be difficult to segment the 
positions taken for market-making purposes from those taken for 
other purposes. More explicitly, proprietary trading can also 
occur when banks employ multiple desks of traders devoted 
solely to position taking for the bank's own account. Both 
types of trading operations, market making and proprietary 
position taking are subject to conflicts of interest 
requirements dictated by regulation and supervisory guidance, 
as well as by industry adopted sound practices.
    Customer accommodation and proprietary trading operations 
at banking organizations are also subject to requirements on 
the adequacy of their internal risk management processes 
including the need for board of directors and senior management 
oversight of established risk tolerances, limits on risk 
taking, risk measurement systems and various types of internal 
controls. Banks are expected to employ multiple measures and 
limits on the risk exposures of their trading operations and 
are encouraged to avoid over-reliance on any single measure or 
limit. Minimum capital requirements and other regulatory 
constraints are also important safeguards in controlling the 
potential impacts of losses in proprietary risk taking, as is 
the market discipline that arises from appropriate disclosure 
of the scale of proprietary trading at banking organizations.
    The recent crisis has surfaced a number of areas for 
improvement, and both international and U.S. supervisors are 
moving forward to address these issues. For example, the Basel 
Committee on Bank Supervision (BCBS) has released international 
standards for stress testing all of a bank's material risk 
exposures. The BCBS has also substantively revised the risk 
management and capital standards applied to banks' trading 
activities and will shortly propose new global standards for 
bank liquidity management that should significantly affect the 
scope and size of banks' proprietary risk taking.
Q.3. Consumer Protection: Interest Rates and State Usury Laws--
One of the defining features of our financial system in recent 
decades has been the spread of financial products that carry 
extraordinarily high interest rates.
    I grew up in a working class family--my dad was a 
millwright. My parents and our neighbors worked hard to send 
their kids to good schools and to own their own homes, and it 
angers me when I see schemes and scams that seem almost 
exclusively geared towards unfairly stripping money out of the 
pockets of working families. When I was Speaker in the Oregon 
legislature, we capped the interest that payday lenders could 
charge--but we couldn't act in other areas because we were told 
its Federal regulation that we couldn't touch.
    It's widely known that just in the payday lending industry, 
75 percent of customers are repeat customers--they come in 
again and again because they are trapped in a cycle of high-
interest debt that they simply cannot escape from. I am hopeful 
that we will see the creation of a strong Consumer Financial 
Protection Agency to police some of these products, but none of 
the proposals give the agency the power to set a national usury 
rate, nor does there seem to be much interest in giving States 
the power to set the usury rate for lending from national 
banks.
    Would you agree that interest rates on some financial 
products, such as payday loans and even some credit cards, are 
simply too high? Why not let States determine the highest rate 
of interest for consumers in their State, and if the citizens 
of a State wish to adopt policies that restrict their own 
credit, let that be the decision of that State?

A.3. The maximum interest rate that a national bank can charge 
is generally the highest rate allowed by the laws of the State 
where the bank is located. This is dictated by the National 
Bank Act, and the Supreme Court has held that a national bank 
may charge the rate allowed by its home State to customers in 
other States. However, if the Congress determined that national 
banks should follow the laws of each State when doing business 
in that State, it could amend the National Bank Act.
    On the one hand, States often are good laboratories for new 
consumer protections to address troublesome products and 
practices. In fact, the Federal Reserve looked at State 
predatory lending laws in developing our HOEPA rules. States 
can also address concerns that are regional in nature. On the 
other hand, there is some benefit and efficiency to a national 
standard, as long as that standard is strong enough to 
adequately protect consumers.
    With respect to payday loans, they do appear to be a very 
expensive form of credit, and some States have legislated in 
this area by adopting restrictions for such loans. The Federal 
Reserve encourages mainstream banks to reach out to unbanked 
consumers, especially in low- and moderate-income 
neighborhoods, to offer them more cost-effective products; and 
we support financial literacy programs to help consumers make 
better choices.

Q.4. Trade and Monetary Policy--For a long time, I've been 
concerned about the regulatory arbitrage inherent in 
international trade between countries with sound labor and 
environmental laws and those without, and how that affects our 
employment situation. More recently, I've also become concerned 
about how international trade imbalances affect our monetary 
policy.
    Failures in consumer protection turned the housing bubble 
into a foreclosure and financial crisis, but as you have noted, 
the existence of the housing bubble itself comes from the 
global savings glut, mostly emanating from trade imbalances 
coming from Asia. The challenge is that traditional monetary 
tools might not even address problems emanating from trade 
imbalances.
    Are you concerned about the monetary policy implications of 
global trade imbalances, and if so, what monetary tools do you 
have to deal with the imbalance going forward? Do you also 
think that we should reduce regulatory arbitrage in trade by 
requiring our trade agreements include stronger provisions to 
raise global labor and environmental rules?

A.4. Policymakers should be concerned about the potential 
implications of global imbalances for the sustainability of 
economic growth as well as the stability of the financial 
system. Countries with large current account surpluses should 
reduce the gap between saving and investment by strengthening 
domestic demand and reducing their dependence on external 
demand. The United States, which runs sizeable current account 
deficits, should increase national savings, importantly by 
committing to reduce Federal budget deficits over time and 
establishing a sustainable trajectory for the public debt.
    The goal of monetary policy in the United States, as 
mandated by Congress, is to pursue maximum sustainable 
employment and stable prices. Global imbalances affect the 
formation of monetary policy insofar as they have implications 
for financial markets, economic activity, employment, and 
inflation. However, monetary policy, by itself, is not well 
suited to address external imbalances. Rather, the goal of the 
Federal Reserve, as given to us by Congress, is to pursue 
maximum employment and stable prices, not to achieve a 
particular level of the trade balance. Our role is to ensure 
the strongest possible macroeconomic environment, by pursuing 
the two legs of our mandate, and to work with fiscal and other 
policymakers to create conditions that will foster a 
sustainable external position. Toward this end, the Federal 
Reserve participates actively in the G20 and other 
international organizations in a cooperative effort to devise 
strategies for dealing with these issues.
    Whether labor and environmental standards should be 
required in trade agreements is a matter of public policy to be 
determined by the Executive and Legislative branches. Clearly, 
policymakers should resist both unfair trade practices and 
protectionist measures. We must also find ways to assuage the 
pain of dislocation that trade may bring to some households, 
firms, and communities. But at the same time, we must not lose 
sight of the fact that our participation in a free and open 
international trading system allows us to enjoy both a more 
productive economy and higher living standards.

Q.5. Federal Reserve Transparency--Many of my constituents are 
deeply angry with the way this financial crisis has unfolded. 
$30 billion in direct asset purchases were provided so JPMorgan 
could acquire Bear Stearns. $300 billion in loan guarantees 
were provided to Citibank, and of course $80 billion in direct 
lending was provided to rescue AIG. And that is just from the 
Fed alone--not even counting TARP. All the while, banks have 
reduced lending and foreclosed on peoples' homes.
    While the Federal Reserve's actions kept the banking system 
from collapse, many people are deeply concerned that the Fed 
could deploy this amount money without any checks and balances 
and without any oversight. I recognize that GAO review of 
monetary policy would be unwise, but when the Fed is engaged in 
propping up failed institutions, that is not monetary policy: 
that's a bailout and should be subject to robust audit.
    For a democratic citizenry to have trust in its government, 
transparency is absolutely essential. You have stated your 
willingness to work with us, and I appreciate the receptivity 
that you have shown to my staff as we have worked on these 
issues. Are you ready to accept a robust audit of the Fed's 
actions relating to emergency bailouts, even as we acknowledge 
that legitimate monetary policy should remain independent?

A.5. I agree that, in a democracy, any significant degree of 
independence by a government agency must be accompanied by 
substantial accountability and transparency. Federal Reserve 
policymakers are highly accountable and answerable to the 
government of the United States and to the American people. As 
you know, the financial statements of the Federal Reserve 
System (including the Reserve Banks) are audited on an annual 
basis by an independent public accounting firm and these 
audited statements are provided to the Congress and made 
publicly available. In addition, the Federal Reserve provides 
the Congress and the public substantial information concerning 
our actions and operations, including the actions we have taken 
during the crisis to protect the stability of the financial 
system and promote the flow of credit. For example, Federal 
Reserve officials regularly testify before Congress and we 
publish a detailed balance sheet on a weekly basis. We also 
provide Congress and the public detailed monthly reports on our 
liquidity programs that detail, among other things, the number 
and distribution of borrowers under each facility; the value, 
type, and quality of the collateral that secures advances under 
each facility, including the loans to prevent the disorderly 
failure of Bear Stearns and AIG; and trends in borrowing under 
the facilities. Moreover, the GAO already has full authority to 
audit the credit facilities the Federal Reserve provided to 
``single and specific'' companies under the authority provided 
by section 13(3) of the Federal Reserve Act. These facilities 
include the loans provided to, or created for, AIG, Bear 
Stearns, and Citigroup under section 13(3).
    We believe permitting the GAO to review the operational 
integrity of the broadly available credit facilities 
established under section 13(3) could provide Congress and the 
public additional comfort regarding the manner in which the 
Federal Reserve is exercising its responsibilities and 
protecting the taxpayer in its operation of these facilities 
without endangering our ability to independently determine and 
implement monetary policy. A review of the operational 
integrity of these facilities could be structured so as not to 
involve a review of the monetary policy aspects of the 
facility, such as the decision to begin or end the facility or 
the choices made regarding, the structure, scope, design, or 
terms of the facility. We remain willing to work with you and 
other members of Congress to implement and perfect such an 
approach. As you recognize, in doing so it is vitally important 
that the independence of monetary policy be preserved. Actions 
that are viewed as weakening monetary policy independence 
likely would increase inflation fears and market interest rates 
and, ultimately, damage economic stability and job creation.

Q.6. Federal Reserve Governance--Although Chairman Dodd's 
legislations strips the Federal Reserve System of its role as a 
banking regulator, the Administration and the House have 
increased the responsibility of the Fed for oversight of bank 
holding companies and other systemically significant firms. 
While the Board of Governors in Washington is ultimately 
responsible for this supervision, the day-to-day supervision is 
conducted by the Reserve Banks under the direction of each 
Reserve Bank president. Although the selection of each Reserve 
Bank's president is overseen by the Board of Governors, the 
boards of directors of the Reserve Banks, which are dominated 
by the member banks, play critical roles and effectively have 
veto power to prevent a regulator they see as too tough. If the 
Federal Reserve does maintain its regulatory authority, do you 
think it is time to change Reserve Bank governance or 
regulatory oversight structure so that the bankers do not have 
any say over who their primary regulator is?

A.6. Under the policies of the Board and the Reserve Banks, the 
boards of directors of the Reserve Banks play no role in the 
supervision or regulation of banking organizations by the 
Federal Reserve and do not have a veto over any supervisory or 
regulatory policy. Supervisory and regulatory policy, 
directions, and decisions are vested in the Board of Governors 
of the Federal Reserve System, all the members of which are 
appointed by the President of the United States and confirmed 
by the U.S. Senate. The Board of Governors has and retains full 
and unfettered authority to remove any officer of a Reserve 
Bank, including the president of a Reserve Bank and any 
examiner or supervisor employed by the Reserve Bank, that does 
not abide by and fully implement the policies, directions, or 
decisions of the Board of Governors regarding supervision and 
regulation of banking organizations.
    The structure of the Federal Reserve, which the Congress 
enacted, has worked well for nearly 100 years and has added 
great strength to the Federal Reserve System. It allows the 
Federal Reserve Board to meet its responsibilities for 
supervising and regulating a diverse group of banking 
organizations throughout the United States. At the same time, 
it allows the Federal Reserve System to benefit from contacts 
in numerous local communities throughout the United States in 
collecting information related to monetary policy. This access 
to a broad array of community and business contacts throughout 
the United States adds real ``Main Street'' anecdotes and 
information to the economic statistics collected nationally.

Q.7. Mortgage-Backed Securities Purchases--One of the more 
creative applications of monetary policy in this crisis is the 
Federal Reserve's purchases of agency mortgage-backed 
securities. By directly purchasing mortgage backed securities, 
the Fed has supported the availability of credit in the housing 
market. Only a few weeks ago, the Fed's purchases of these 
agency MBS topped $1 trillion, and the program was announced to 
remain in effect through March. Moreover, TALF, which supports 
the private label securitization markets, has been extended 
through June of 2010.
    When will the housing and other securitization markets be 
strong enough to operate on their own? What risk is the Fed 
taking on in these purchases? Is this an appropriate type of 
monetary policy action over the long term, one that you expect 
to use again?

A.7. Financial market functioning has, in general, improved 
substantially since the spring of this year. For example, 
spreads between yields on private debt securities and Treasury 
debt have returned toward more normal levels at both short and 
long maturities even as corporate bond issuance this year has 
exceeded last year's issuance. In private-label securitization 
markets, issuance of shorter-term asset-backed securities 
backed by consumer and small business loans has increased: Some 
of those issues were supported by TALF; others were not. 
Recently, the TALF financed the first new commercial mortgage-
backed security (CMBS) since 2008; other CMBS have since come 
to market without TALF support. While usage of the TALF has 
continued to expand at a modest rate, usage of the Federal 
Reserve's other credit and liquidity facilities has declined 
rapidly as market functioning improved.
    In light of the ongoing improvement in financial market 
functioning, usage of the Federal Reserve's liquidity 
facilities has declined dramatically, and a number of these 
facilities are scheduled to close early next year. We also 
anticipate ending the current program of MBS purchases at the 
end of the first quarter. The Board and the FOMC will of course 
continue to evaluate the evolving economic outlook and 
conditions in financial markets and are prepared to extend some 
or all of its programs if that proves necessary.
    With respect to risks the Federal Reserve has taken on, we 
have, as noted in the question, purchased agency-guaranteed 
MBS. Because of the agency guarantee, the Federal Reserve has 
no exposure to credit losses stemming from defaults on the 
underlying mortgages. However, the fair market value of MBS can 
and does vary in response to movements in longer-term interest 
rates.
    Finally, the Federal Reserve believes that the TALF, other 
liquidity and credit facilities, and large-scale asset 
purchases were appropriate steps in light of the severe 
financial dysfunction and contracting economic activity, as 
well as the fact that the Federal Reserve had taken the Federal 
funds rate essentially as low as possible. In general, these 
steps would be neither necessary nor appropriate in more normal 
times, and I certainly hope conditions will not warrant using 
them again.

       RESPONSES TO WRITTEN QUESTIONS OF SENATOR BUNNING
                      FROM BEN S. BERNANKE

Q.1. Please provide:

  a.  Unreleased transcripts of all FOMC meetings you 
        participated in as a Governor or Chairman.

  b.  Unreleased transcripts of all Board of Governors meetings 
        you participated in as a Governor or Chairman.

  c.  Transcripts and minutes of meetings of the board of the 
        Federal Reserve Bank of New York during your tenure as 
        Chairman of the Board of Governors.

  d.  Details, including any unreleased administrative notices, 
        on any exemptions granted or denied to Federal Reserve 
        Act sections 23(a) and 23(b) during your tenure as 
        Chairman.

  e.  Details of all discount window transactions during your 
        tenure as Chairman, including the date, amount, 
        identity of the borrower, details of any collateral 
        posted, explanation of the valuation of any collateral 
        posted, any analysis of the health of the borrower at 
        the time of the transaction, and any legal opinions 
        regarding the transaction.

  f.  Details of all transactions at facilities created under 
        section 13(3) of the Federal Reserve Act during your 
        tenure as Chairman, including the date, amount, 
        identity of the borrower, details of any collateral 
        posted, explanation of the valuation of any collateral 
        posted, any analysis of the health of the borrower at 
        the time of the transaction, and any legal opinions 
        regarding the transaction.

  g.  Copies of any swap or other agreements with foreign 
        central banks, legal opinions related to those 
        agreements, and any analysis of the agreements or the 
        need for the agreements.

  h.  Any economic analysis or policy materials regarding the 
        need for or effectiveness of any Federal Reserve 
        facilities created under Federal Reserve Act section 
        13(3).

  i.  Any economic analysis or policy materials regarding the 
        need for or effectiveness of unconventional monetary 
        policy facilities or actions taken during your tenure 
        as Chairman.

  j.  Any transcripts, minutes, details, legal opinions, 
        economic analysis, phone call logs, policy materials, 
        or any other relevant information from the FOMC, the 
        Board of Governors, the Federal Reserve Bank of New 
        York, or other relevant body not provided under the 
        above requests regarding the use of Federal Reserve Act 
        section 13(3) or actions and decisions regarding AIG, 
        Bank of America, Citigroup, Bear Stearns, Lehman 
        Brothers, General Motors, Chrysler, CIT, or GMAC.

A.1. Without addressing every specific item, I believe that the 
release of much of the information requested would inhibit the 
policymaking process or reduce the effectiveness of policy and 
thus would not be in the public interest.
    Making public the information you request regarding policy 
deliberations (including meeting transcripts and related 
documents) could stifle the Federal Reserve's policy 
discussions, limiting the ability of participants to engage in 
the candid and free exchange of views about alternative 
approaches that is necessary for effective policy. Although 
transcripts are not released for 5 years (and I believe that we 
are the only major central bank that does make transcripts 
public), we provide extensive information about our 
deliberations, including through Committee statements, minutes, 
quarterly economic projections, testimonies, speeches, the 
semi-annual Monetary Policy Report to the Congress, and other 
vehicles.
    The detailed information you have requested regarding 
participation in Federal Reserve's broad-based lending programs 
would significantly undermine the usefulness of such programs. 
The critical purpose of these programs is to provide 
institutions that have temporary liquidity needs with a means 
to meet those needs by coming to the Federal Reserve. Releasing 
the names of institutions that borrow would stigmatize such 
borrowing, making firms less willing to come to the Federal 
Reserve and so make it more difficult for the Federal Reserve 
to respond to financial market strains. Moreover the Federal 
Reserve has been highly responsible in its use of these 
programs. For example, our discount window loans are fully 
collateralized, and we have never lost a penny on such 
operations. Likewise, the loans made under section 13(3) have 
been fully secured. We provide extensive information regarding 
the number of institutions to which we are lending under each 
of our credit programs, and the type of collateral we have 
accepted, on our Web site, as well as information on exemptions 
granted under sections 23A and 23B of the Federal Reserve Act.
    Finally, the release of staff analyses could have adverse 
effects on Federal Reserve policy. In order for the Federal 
Reserve staff to be able to provide its best policy analysis 
and advice to policymakers, it is necessary for some staff 
analysis to be kept confidential for a period of time. Release 
of such information could expose Federal Reserve staff to 
political pressure. Such pressure could lead the staff to omit 
more sensitive material from its policy analyses and more 
generally might cause the staff to skew its analyses and 
judgments. That outcome could have serious adverse effects on 
Federal Reserve policy decisions, to the detriment of the 
performance of our economy.
    The Federal Reserve is very transparent. On a weekly, 
monthly, quarterly, semi-annual, and annual basis, the Federal 
Reserve provides to the public in-depth and detailed 
information regarding its operations, activities, and policy 
decisions. These materials include:

    Weekly Balance Sheets--H.4.1 Release (See December 
        10, 2009, Release, attached as Ex. 1, tab A) (also 
        available on our public Web site: http://
        www.federalreserve.gov/monetarypolicy/
        bst_fedsbalancesheet.htm);

    Monthly Transparency Reports (See November 2009 
        Report, attached as Ex. 1, tab B) (also available on 
        our public Web site: http://www.federalreserve.gov/
        monetarypolicy/files/monthlyclbsreport200911.pdf);

    Policy statements released immediately following 
        each FOMC Meeting (See November 4, 2009, Release, 
        attached as Ex. 1, tab C) (also available on our public 
        Web site: http://www.federalreserve.gov/newsevents/
        press/monetary/20091104a.htm);

    Minutes of each FOMC Meeting (See November 3-4, 
        2009 Minutes, attached as Ex. 1, tab D) (also available 
        on our public Web site: http://www.federalreserve.gov/
        monetarypolicy/files/fomcminutes20091104.pdf);

    Semiannual Monetary Policy Report and Testimony 
        (See July 2009 Report, attached as Ex. 1, tab E) (also 
        available on our public Web site: http://
        www.federalreserve.gov/monetarypolicy/files/
        20090721_mprfullreport.pdf);

    Annual audit of the Federal Reserve's financial 
        statement provided by independent accounting firm (See 
        Audit, published in Annual Report and attached 
        separately as Ex. 1, tab F) (also available on our 
        public Web site: http://www.federalreserve.gov/
        boarddocs/rptcongress/annual08/pdf/audits.pdf); and

    Voluminous information on policy actions available 
        on our public Web site: http://www.federalreserve.gov/
        monetarypolicy/bst.htm.

    In addition, the Federal Reserve has submitted one 
statement for the record and testified before Congress 43 times 
this calendar year, including:

    Thirteen appearances by the Chairman;

    Three appearances by the Vice Chairman;

    Nine appearances by the Governors;

    Twelve appearances by the Staff of the Board of 
        Governors; and

    Six appearances by the Presidents, Vice Presidents, 
        and Staff of the Reserve Banks.

    Further, the Federal Reserve has already been audited 
numerous times in 2009, including:

    The Annual Audit (as mentioned); and

    GAO Audits of nonmonetary policy, which total 33 to 
        date--24 completed and 9 in process (reports of the 
        audits are available on GAO's Web site: http://
        www.gao.gov/docsearch/repandtest.html).

Q.2. Treasury published the names of banks that received TARP 
funds without causing a panic. Why would disclosing the names 
of companies that borrow at the discount window or other Fed 
facilities be different, especially if only released after a 
time delay?

A.2. It is essential that participants in our liquidity 
programs remain confident that their usage of these programs 
will be held in confidence. If borrowers instead fear that 
market participants and others may learn about their usage of 
these programs, then they will be less inclined to borrow, 
reducing the effectiveness of the programs for countering 
pressures in financial markets. This is not just a theoretical 
possibility. When the strains in financial markets erupted in 
August 2007, banks were quite reluctant to utilize the primary 
credit program out of concern that their borrowing would be 
discovered by market participants and interpreted as a sign of 
financial weakness. Indeed, that stigma significantly reduced 
the effectiveness of the primary credit program, and prompted 
the Federal Reserve to establish the Term Auction Facility and 
other programs to more directly address liquidity pressures.

Q.3. What was the involvement of the Board of Governors in each 
transaction by the New York Fed under Federal Reserve Act 
section 13(3)? Did the Board materially alter the terms of any 
such transaction? Did the Board approve each transaction before 
the New York Fed began negotiations? Please provide other 
relevant information and documentation.

A.3. As required by section 13(3) of the Federal Reserve Act, 
the Board of Governors considered and approved, by an 
affirmative vote of not less than the required number of 
members, each credit facility established under the authority 
of that provision, after making the required determination that 
unusual and exigent circumstances existed. Prior to Board of 
Governors approval of these facilities, Board of Governors and 
New York Federal Reserve Bank staff worked together to 
structure the proposal that was presented to the Board of 
Governors for approval. As authorized by section 13(3), the 
Board of Governors imposed specific limits and conditions on 
these credit facilities as appropriate to the particular 
facility. Detailed information concerning each of the credit 
facilities authorized by the Board under section 13(3) is 
available on the Board's public Web site.

Q.4. Did anyone, including the White House or Treasury, request 
commitments from you surrounding your renomination? Did you 
make any commitments regarding your renomination?

A.4. No one has requested any commitments from me in connection 
with my renomination, nor have I made any commitments other 
than what I said in my statement before the Senate Banking 
Committee that, if reappointed, I will work to the utmost of my 
abilities in the pursuit of the monetary policy objectives 
established by Congress to promote price stability and maximum 
employment.

Q.5. We saw the crowding out of the private mortgage market 
caused by Freddie and Fannie's overwhelming control of 
mortgages during 2002 to 2006 period. Do you think there is a 
danger to allowing an extended public-controlled mortgage 
market? And what steps is the Fed taking to reestablish a 
private mortgage market?

A.5. The U.S. mortgage market has had extensive government 
involvement for many decades, including Fannie Mae, Freddie 
Mac, the Federal Housing Administration, Ginnie Mae, and the 
Federal Home Loan Banks. That involvement has had important 
benefits, including the development of the mortgage 
securitization market. However, as the placing of Fannie Mae 
and Freddie Mac into conservatorship shows, the under-
capitalization of the GSEs together with the implicit 
government guarantee has also imposed heavy costs on the 
taxpayer. The Congress will need to address the appropriate 
role of the GSEs in the future of the mortgage market.
    The Federal Reserve's agency debt and mortgage-backed 
securities purchase programs stabilized the functioning of 
private secondary mortgage markets during the height of the 
financial turmoil. These actions also provided significant 
benefits to primary mortgage markets.

Q.6. Time and energy in macroeconomic analysis is spent 
attempting to measure business and consumer confidence. 
Confidence measures are part of macroeconomic forecasting and 
directly impact monetary policy decisions. Likewise, certain 
market movements reflect investor confidence or lack of 
confidence. Gold is at an all-time high because investors have 
lost confidence in policymakers' handling of fiat currencies. 
How is the Fed incorporating this market information into its 
analytical framework? Does the lack of confidence in fiat 
currencies have the potential to impact monetary policy?

A.6. Gold is used for many purposes, including as a reserve 
asset, as an investment, and for use in electronics, 
automobiles, and jewelry. Thus, fluctuations in the price of 
gold can reflect changes in demand associated with any of these 
uses, as well as changes in supply. In monitoring the price of 
gold, the Federal Reserve must attempt to interpret which of 
these factors is responsible for its fluctuations at any point 
in time. One of the ways we do this is by consulting other 
indicators of market sentiment. A number of measures of 
expected future inflation in the United States, including 
measures taken from inflation-protected bonds and surveys of 
consumers and professional forecasters, have been well 
contained. Accordingly, increases in the price of gold do not 
appear to reflect increases in the expected future of U.S. 
inflation.

Q.7. Paul Krugman recently wrote about the problem policymakers 
will face in the future because of the public's lack of trust. 
The public backlash regarding what it sees as unwarranted 
bailouts of banks is well-known. What is the Fed doing to 
restore public confidence and what are the potential negative 
implications of this lack of trust on the Fed's ability to 
conduct monetary policy?

A.7. The public's frustration with the support provided banks 
and certain other financial institutions is understandable. 
Unfortunately, withholding the support would have resulted in a 
substantially more severe economic recession with significantly 
greater job losses. My colleagues and I on the Federal Reserve 
Board are taking every opportunity, including through speeches 
and Congressional testimony, to explain to the public the 
reasons for the Federal Reserve's actions. Moreover, we fully 
support the efforts under way--in particular, strengthening 
supervision of systemically critical institutions and 
developing a regime to prevent the disorderly failure of 
systemically important nonbank financial institutions while 
imposing losses on the shareholders and creditors of such 
firms--to reduce the odds that similar support will be needed 
in the future.
    Most critical for the Federal Reserve's ability to conduct 
monetary policy is the public's confidence in our commitment to 
achieving our dual mandate of maximum employment and price 
stability. The public's confidence in our commitment should be 
bolstered by the Federal Reserve's swift and forceful monetary 
policy response to the financial crisis and resulting recession 
and by our careful development of tools that will facilitate 
the firming of monetary policy at the appropriate time even 
with a large Federal Reserve balance sheet.

Q.8. What are the limits on the ability of the Fed to engage in 
quantitative easing?

A.8. A central bank engages in quantitative easing when it 
purchases large quantities of securities, paying for them with 
newly created bank reserve deposits, to increase the supply of 
bank reserves well beyond the level necessary to drive very 
short-term interbank interest rates to zero. The Federal 
Reserve's large-scale asset purchases have been intended 
primarily to improve conditions in private credit markets, such 
as mortgage markets; the increase in the quantity of reserves 
is largely a byproduct of these actions. In any case, while 
large-scale asset purchases can help support financial market 
functioning and the availability of credit, and thus economic 
recovery, excessive expansion of bank reserves could result in 
rising inflation pressures. Congress has given the Federal 
Reserve a dual mandate to promote maximum employment and stable 
prices. That mandate appropriately gives the Federal Reserve 
flexibility to engage in quantitative easing to combat high 
unemployment and avoid deflation while requiring that it avoid 
quantitative easing that would be so large or prolonged that it 
could cause persistent inflation pressures.

Q.9. In 2002-2005 period, we learned that there is a cost to 
keeping interest rates too low for too long. And, we learned it 
is much more difficult to tighten policy/raise interest rates 
after a period of low rates for a long time. Now, you have 
taken rates to unprecedented low levels and have also 
intervened in the mortgage market to produce historic low 
mortgage rates. If the U.S. economy bounces back more strongly 
than currently anticipated, isn't the Fed going to have a very 
tough time raising interest rates without once again impacting 
asset prices, especially the housing market?

A.9. Federal Reserve policymakers consistently have said, in 
the statements that the Federal Open Market Committee releases 
immediately after each of its meetings and in their speeches, 
that the Federal Reserve will evaluate its target for the 
Federal funds rate and its securities purchases in light of the 
evolving economic outlook and conditions in financial markets. 
In that regard, we announced that we plan to end our purchases 
of mortgage-backed securities at the end of the first quarter 
of 2010; we also announced--and have implemented--a gradual 
reduction in the pace of our purchases of such securities. More 
recently, we made clear that the low target for the Federal 
funds rate is conditional on low rates of resource utilization, 
subdued inflation trends, and stable inflation expectations. As 
the economy continues to recover, it will eventually become 
appropriate to raise our target for the Federal funds rate and 
perhaps take other steps to reduce monetary policy 
accommodation. Our continuing communication about monetary 
policy should ensure that market participants and others are 
not greatly surprised by our actions and thus help avoid sharp 
adjustments in asset prices.

Q.10. What is the Fed's current thinking about using asset 
price levels in monetary policy analysis? Does the Fed need to 
anticipate asset bubbles? How can the Fed incorporate asset 
prices into their analysis?

A.10. Asset prices play an important role in the analysis that 
underpins the conduct of monetary policy by the Federal 
Reserve. We carefully monitor a wide range of asset prices (as 
well as other aspects of financial market conditions) and 
assess their implications for the goal variables that the 
Congress has given us, namely inflation and employment. There 
is a widely held consensus that central banks should counteract 
the effects of asset prices on the ultimate goal variables in 
this manner.
    What is less clear is whether the Federal Reserve should 
attempt to use monetary policy to ``lean against'' bubbles in 
asset prices by tightening monetary policy more than would be 
indicated by the medium-term outlook for real activity and 
inflation alone. To be sure, the experience of the past 2 years 
provides a vivid illustration of the economic devastation that 
can be wrought by an asset price bubble first building up and 
then bursting. However, three important challenges would have 
to be surmounted before tighter monetary policy could be deemed 
an effective response to bubbles: First, we would have to be 
confident in our ability to detect bubbles at an early stage in 
their development, given substantial lags in the effects of 
monetary policy on real activity and inflation, and the general 
need for policy to ease in response to the economic weakness 
that follows a bubble's collapse. Second, we would have to be 
confident that the steps we took to restrain a bubble in one 
sector would not cause so much harm in other sectors as to 
leave the economy worse off, on net, than if we had not acted. 
Finally, we would have to be confident that an adjustment in 
the stance of monetary policy would be effective in restraining 
the bubble itself. It is not clear that these conditions can 
all be met. And even if they could, we would still have to 
determine that some alternative to tighter monetary policy 
would not be a better way of responding to the problem.
    At this stage, it seems to me that the exercise of 
regulatory and supervisory policy is likely to be a more 
effective approach to addressing issues posed by possible 
bubbles. Regulators have an ongoing responsibility to ensure 
the safety and soundness of the institutions under their care; 
and this responsibility implies a need to monitor closely the 
actions of the firm that might cause it to be exposed to risks 
of all types, including those actions that might contribute to 
the development of a bubble as well as the possible effects on 
the firm of the bursting of an asset price bubble. On balance, 
therefore, I see a comprehensive and aggressive macroprudential 
regulatory framework as likely to be the more promising means 
of preventing and restraining asset-price bubbles.
    All that said, we are giving the issue fresh consideration 
and attempting to incorporate into our analysis the lessons of 
the last 2 years in this regard.

Q.11. The Fed appears to have coordinated some of its actions 
in the past year or so with other policymakers globally. Does 
the Fed have an obligation to disclose any of these agreements 
or coordinated efforts? When the Fed engages in agreements with 
foreign policymakers, it has the potential to abrogate its 
authority. What procedures are in place to make sure this 
doesn't happen? What checks and balances are in place?

A.11. In the past year or so, the Federal Reserve has 
implemented and disclosed policy actions that have been 
coordinated with actions taken by policymakers from other 
countries. These actions include both the use of central bank 
liquidity swaps, which have been in place since December 2007, 
and a reduction in the target for the Federal funds rate in 
October 2008, which occurred in conjunction with similar rate 
actions by other central banks. The Federal Reserve announced 
these actions in press releases and maintains detailed 
information with respect to them on our Web site.
    The authority for these operations is well established. 
Policy rate operations clearly fall within the purview of the 
monetary policy authority of the Federal Reserve, and the 
Federal Reserve Act and longstanding historical precedent 
support the authority of the Federal Reserve to engage in swap 
operations with foreign central banks. We are committed to 
being as transparent as possible about our policies and 
operations without undermining our ability to effectively 
fulfill our monetary policy and other responsibilities. The 
Federal Reserve regularly reports to the Congress and provides 
both the Congress and the public with a full range of detailed 
information concerning its policy actions, operations, and 
financial accounts, including arrangements with foreign central 
banks such as the liquidity swaps. The Chairman of the Federal 
Reserve Board testifies and provides a report to the Congress 
semiannually on the state of the economy and on the Federal 
Reserve's actions to carry out the monetary policy objectives 
that the Congress has established, and Federal Reserve 
officials frequently testify before the Congress on all aspects 
of the Federal Reserve's responsibilities and operations, 
including economic and financial conditions and monetary 
policy.

Q.12. China is playing a larger and larger role in the growth 
trajectory of the global economy. And, China is one of the 
largest U.S. creditors. Yet, the macroeconomic data from China 
is notoriously untrustworthy. How is the Fed conducting its 
analysis of the Chinese macroeconomic outlook without access to 
good data?

A.12. While macroeconomic data from China vary in quality, 
their reliability appears to be improving, and they now provide 
a reasonable picture of what is going on. In addition to data 
from China, one can also examine Chinese international trade by 
looking at the statistics produced by its major trading 
partners, including the United States. At the Federal Reserve, 
we monitor a wide range of Chinese and international data in 
analyzing Chinese economic and policy developments. We also 
closely follow studies on China performed by independent 
experts, and keep regular contact with these experts, Chinese 
academics and authorities, and other U.S. agencies. Through all 
these means, we are able to put together a satisfactory 
assessment of the performance of the Chinese economy, allowing 
us to make an informed projection of the country's economic 
outlook and its implications for the U.S. economy.

Q.13. There are a number of macro trends at work that do not 
seem sustainable--(1) the substantial accumulation of foreign 
exchange reserves by surplus/creditor nations, (2) the 
escalation of public debt levels in many of the developed 
market economies, and (3) excess and deficient savings ratios. 
These trends do not seem likely to reverse on their own. 
Rather, they require tough decisions and compromise on the part 
of governments around the world. What is the role of the Fed in 
this rebalancing process?

A.13. To achieve more balanced and sustainable economic growth 
and to reduce the risks of financial instability, economies 
throughout the world must act to contain and reduce global 
imbalances. In current account surplus countries, including 
most Asian economies, authorities must act to narrow the gap 
between saving and investment and to raise domestic demand, 
especially consumption. As a country with a current account 
deficit, the United States must increase its national saving 
rate by encouraging private saving and, more importantly, by 
establishing a sustainable fiscal trajectory, anchored by a 
clear commitment to substantially reduce Federal deficits over 
time. By the same token, other countries experiencing large 
increases in public debt must implement credible fiscal 
consolidation policies.
    Monetary policy, by itself, is not well suited to address 
external imbalances. Rather, the goal of the Federal Reserve, 
as given to us by Congress, is to pursue maximum employment and 
stable prices, not to achieve a particular level of the trade 
balance. Our role is to ensure the strongest possible 
macroeconomic environment, by pursuing the two legs of our 
mandate, and to work with fiscal and other policymakers to 
create conditions that will foster a sustainable external 
position. Toward this end, the Federal Reserve participates 
actively in the G20 and other international organizations in a 
cooperative effort to devise strategies for dealing with these 
issues.

Q.14. Please explain the legality of each version of the AIG 
bailout/loans. How were each of the loans to AIG 
collateralized?

A.14. Each of the facilities established by the Federal Reserve 
was authorized and established under section 13(3) of the 
Federal Reserve Act (12 U.S.C. 343). Section 13(3) permits the 
Board, in unusual and exigent circumstances, to authorize a 
Federal Reserve Bank to provide a loan to any individual, 
partnership, or corporation if, among other things, the loan is 
secured to the satisfaction of the Reserve Bank and the Reserve 
Bank obtains evidence that the individual, partnership or 
corporation is unable to secure credit accommodations from 
other banking institutions.
    As described in more detail in the Board's Monthly Report 
on Credit and Liquidity Programs and the Balance Sheet and the 
reports filed by the Board under section 129 of the Emergency 
Economic Stabilization Act of 2008, the:

    Revolving Credit Facility with AIG is secured by 
        the pledge of assets of AIG and its primary 
        nonregulated subsidiaries, including AIG's ownership 
        interest in its regulated U.S. and foreign 
        subsidiaries;

    The loan to Maiden Lane II LLC (ML-II) is secured 
        by all of the residential mortgage-backed securities 
        and other assets of ML-II, as well as by a $1 billion 
        subordinate position in ML-II held by certain of AIG's 
        U.S. insurance subsidiaries; \1\ and
---------------------------------------------------------------------------
     \1\ Upon establishment of the ML-II facility, the securities 
borrowing facility that the Federal Reserve had established for AIG in 
October 2008 was terminated. Advances under this securities borrowing 
facility were fully collateralized by investment grade debt 
obligations.

    The loan to Maiden Lane III LLC (ML-III) is secured 
        by all of the multi-sector collateralized debt 
        obligations and other assets of ML-III, as well as a $5 
        billion subordinated position in ML-III held by an AIG 
---------------------------------------------------------------------------
        affiliate.

Q.15. The most recent changes to the AIG bailout give the New 
York Fed equity in AIG subsidiaries in exchange for loan 
forgiveness. Under what section of the Federal Reserve Act are 
those equity stakes permissible? Please provide any legal 
opinions on the subject.

A.15. The Federal Reserve Bank of New York received the 
preferred equity in the two special purpose vehicles 
established to hold the equity of two insurance subsidiaries of 
AIG in satisfaction of a portion of AIG's borrowings under the 
revolving credit facility established under section 13(3) of 
the Federal Reserve Act. As a result of the receipt of these 
preferred interests, AIG's borrowings under the revolving 
credit facility were reduced by $25 billion, and the maximum 
amount available under the facility was reduced from $60 
billion to $35 billion. The amount of preferred equity received 
by the Federal Reserve was based on valuations prepared by an 
independent valuation firm. The revolving credit facility 
continues to be fully secured by nearly all of the remaining 
assets at AIG. We continue to believe, based on these 
valuations and collateral positions, that the Federal Reserve 
will be fully repaid.

Q.16. The most recent changes to the AIG bailout give the New 
York Fed equity in AIG subsidiaries in exchange for loan 
forgiveness. Does that indicate that the original ``loans'' 
were not really collateralized loans at all, rather they were 
equity stakes?

A.16. No. The revolving credit facility established for AIG in 
September 2008 was and is fully secured by assets of AIG and 
its primary nonregulated subsidiaries, including AIG's 
ownership interest in its regulated U.S. and foreign 
subsidiaries.
    The facility is fully secured by the assets of AIG, 
including the shares of substantially all of AIG's 
subsidiaries. The loan was extended with the expectation that 
AIG would repay the loan with the proceeds from the sale of its 
operations and subsidiaries. AIG has developed and is pursuing 
a global restructuring and divestiture plan that is designed to 
achieve this objective and a number of significant sales 
already have occurred. The credit agreement stipulates that the 
net proceeds from all sales of subsidiaries of AIG must first 
be used to pay down the credit extended by the Federal Reserve.

Q.17. When the first nine large banks received the initial 125 
billion TARP dollars, Secretary Paulson and you said those nine 
banks were healthy. Do you now agree with the TARP Inspector 
General's finding that Citigroup and Bank of America should not 
have been considered healthy by you and Secretary Paulson?

A.17. On October 14, 2008, the Federal Reserve joined in a 
press release with Treasury and the FDIC to announce a number 
of steps to address the financial crisis, including announcing 
the implementation of the Capital Purchase Program (``CPP''). 
The first nine banks to receive CPP funds were selected because 
of their importance to the financial system at large. In fact, 
the SIGTARP report notes that approximately 75 percent of all 
assets held by U.S.-owned banks were held by these nine 
institutions. In addition, these first nine institutions were 
considered to be viable, though some were financially stronger 
than others. The press release referred to these nine 
systemically important institutions as ``healthy'' to indicate 
that these institutions were viable and were not receiving 
government funds because they were in imminent danger of 
failure.

Q.18. In 2008, you came to Congress and warned of a 
catastrophic financial collapse if we did not authorize TARP. 
One major problem you predicted was that companies would not be 
able to sell commercial paper. However, the Fed has the 
authority to buy that same commercial paper and in fact, you 
created a lending facility to buy commercial paper the week 
after TARP was approved. Did the Fed already have plans to 
implement this facility before you and Secretary Paulson came 
to Congress requesting TARP?

A.18. The commercial paper market was severely disrupted by the 
financial crisis, in particular after Lehman Brothers failed on 
September 15, 2008, and a large money fund broke the buck the 
following day. The Federal Reserve created three facilities in 
response to the dislocation in money markets, each of which was 
designed to finance purchases of commercial paper. The Asset-
Backed Commercial Paper Money Market Mutual Fund Liquidity 
Facility (AMLF) was announced on September 19, 2008. The 
Commercial Paper Funding Facility (CPFF) was announced on 
October 7, 2008. And the Money Market Investor Funding Facility 
(MMIFF) was announced on October 21, 2008. Your question refers 
to the CPFF, which was announced the week after the TARP was 
approved. All of these facilities helped address strains in 
money markets, but they did not replace the commercial paper 
market completely, and the ability of firms to sell commercial 
paper was severely impaired.
    On September 18, 2008, Secretary Paulson and I met with 
Congressional leadership to discuss the financial situation and 
explain our view that the global financial system was on the 
verge of a collapse. We expressed concern about a number of 
areas of the economy and financial markets, including as one 
example the potential collapse of the commercial paper market. 
At that time, the Federal Reserve was working towards 
developing the AMLF. The Federal Reserve began to think about 
constructing the CPFF after observing the effects of the 
failure of Lehman Brothers on the commercial paper market. The 
limitations on the Federal Reserve's ability to address the 
numerous problems that were rapidly emerging in financial 
markets in the fall of 2008 spurred the decision by then-
Secretary Paulson and me to approach the Congress. As we 
explained to Congress, the tools available to the agencies at 
the time were insufficient to address the serious stresses 
facing the financial markets, and action by Congress was 
necessary to stem the crisis.

Q.19. When you came to Congress last September requesting 
Congress to pass TARP, did you have any inclination that those 
funds would be used for something else besides buying toxic 
assets?

A.19. Last September, the financial and economic situation was 
evolving very rapidly. In particular, the situation--which was 
already very grave when Secretary Paulson and I began our 
intensive consultations with the Congress--had deteriorated 
sharply further by the time when the legislation authorizing 
the TARP was enacted. What was clear from the outset of those 
intensive consultations was that the financial system was in 
substantial danger of seizing up in a way that had not occurred 
since at least the Great Depression, and that would have led to 
an even worse economic collapse than the one that we have 
actually experienced. What was not clear, however, was the 
strategy that would be most effective in arresting that process 
of seizing up. Initially, the strategy that, indeed, received 
the most attention envisioned using the resources anticipated 
to be provided under the TARP to purchase so-called toxic 
assets off the balance sheets of private financial 
institutions, in order to improve the transparency of those 
balance sheets and to create the capacity for the private 
institutions to engage in new lending. Even until Lehman 
Brothers fell, the issues plaguing the financial system were 
closely linked to mortgages, and indeed so too were the options 
being considered most seriously. Only after the aftershocks of 
Lehman's failure sapped confidence in the broader set of 
financial institutions, and interbank markets seized up, did it 
become clear to Treasury that providing large amounts of 
capital to viable banks would be a superior response to the 
profound and rapid deterioration that had become the immediate 
concern, in substantial part because capital injections could 
be implemented much more quickly than asset purchases. These 
capital injections provided a means to reinforce confidence in 
the banking system and its ability to absorb potential losses 
while retaining an ability to lend to creditworthy borrowers. 
The Federal Reserve supported the Treasury's decision to adopt 
the capital-purchase strategy.

Q.20. In your discussions with Ken Lewis about Bank of 
America's acquisition of Merrill Lynch, did you mention the 
consequences he could face regarding his employment if Bank of 
America did not go through with this deal?

A.20. As I indicated in my June 2009 testimony before the House 
Committee on Oversight and Government Reform, in my discussions 
with senior management of Bank of America about the Merrill 
Lynch acquisition, I did not tell Ken Lewis, the CEO of Bank of 
America, or the other managers of the institution that the 
Federal Reserve would take action against the board of 
directors or management of the company if they decided not to 
complete the acquisition by invoking a Material Adverse Change 
(MAC) clause in the acquisition agreement. It was my view, as 
well as the view of others, that the invocation of the MAC 
clause in this case involved significant risk for Bank of 
America, as well as for Merrill Lynch and the financial system 
as a whole, and it was this concern I communicated to Mr. Lewis 
and his colleagues. The decision to go forward with the 
acquisition rightly remained in the hands of Bank of America's 
board of directors and management.
    A recent report by the Special Inspector General for the 
Troubled Asset Relief Program with regard to government 
financial assistance provided to Bank of America and other 
major banks confirmed, after review of relevant documents, that 
there was no indication that I expressed to Mr. Lewis any views 
about removing the management of Bank of America should the 
Merrill Lynch acquisition not occur.

Q.21. Why was the SEC not notified of the Bank of America/
Merrill Lynch deal?

A.21. The SEC was fully aware of the deal by Bank of America 
Corporation (BAC) to acquire Merrill Lynch. Chairman Cox was 
present in New York when BAC announced the deal in September 
2008. The SEC staff discussed details of the Merrill Lynch 
acquisition with BAC. The SEC was not a party to the 
arrangement by the Treasury, Federal Reserve, and FDIC to 
provide a ring fence for certain assets of BAC in mid-January 
2009 and therefore had no role in negotiating the arrangement, 
though it was informed of the arrangement.

Q.22. When was the first time you became aware of AIG's 
potential vulnerability? Did anyone raise any kind of red flag 
to you about AIG exploiting regulatory loopholes?

A.22. The Federal Reserve did not have, and does not have, 
supervisory authority for AIG and therefore did not have access 
to nonpublic information about AIG or its financial condition 
before being contacted by AIG officials in early September 
2008, concerning the company's potential need for emergency 
liquidity assistance from the Federal Reserve.

Q.23. According to the TARP Inspector General, the Fed Board 
approved the New York Fed's decision to pay par on AIG's credit 
default swaps. What was your role in that decision, and why was 
it approved?

A.23. I participated in and supported the Board's action to 
authorize lending to Maiden Lane III for the purpose of 
purchasing the CDOs in order to remove an enormous obstacle to 
AIG's future financial stability. I was not directly involved 
in the negotiations with the counterparties. These negotiations 
were handled primarily by the staff of FRBNY on behalf of the 
Federal Reserve.
    With respect to the general issue of negotiating 
concessions, the FRBNY attempted to secure concessions but, for 
a variety of reasons, was unsuccessful. One critical factor 
that worked against successfully obtaining concessions was the 
counterparties' realization that the U.S. government had 
determined that AIG was systemically important and accordingly 
would act to prevent AIG from undergoing a disorderly failure. 
In those circumstances, the government and the company had 
little or no leverage to extract concessions from any 
counterparties, including the counterparties on multi-sector 
CDOs, on their claims. Furthermore, it would not have been 
appropriate for the Federal Reserve to use its supervisory 
authority on behalf of AIG (an option the report raises) to 
obtain concessions from some domestic counterparties in purely 
commercial transactions in which some of the foreign 
counterparties would not grant, or were legally barred from 
granting, concessions. To do so would have been a misuse of the 
Federal Reserve's supervisory authority to further a private 
purpose in a commercial transaction and would have provided an 
advantage to foreign counterparties over domestic 
counterparties. We believe the Federal Reserve acted 
appropriately in conducting the negotiations, and that the 
negotiating strategy, including the decision to treat all 
counterparties equally, was not flawed or unreasonably limited.
    It is important to note that Maiden Lane III acquired the 
CDOs at market price at the time of the transaction. Under the 
contracts, the issuer of the CDO is obligated to pay Maiden 
Lane III at par, which is an amount in excess of the purchase 
price. Based on valuations from our advisors, we continue to 
believe the Federal Reserve's loan to Maiden Lane III will be 
fully repaid.

Q.24. Did Fed regulators of Citi approve the $8 billion loan 
Citi made to Dubai in December of last year, which was well 
after the firm received billions of taxpayer dollars? Do you 
expect we will get that money back?

A.24. With the exception of mergers and acquisitions, the 
Federal Reserve does not pre-approve individual transactions of 
the financial institutions we supervise. Whether Citi is able 
to recover this or any other loan it extends is a function of 
the standards it applied when it underwrote the loan. 
Nevertheless, the U.S. government's recovery of the TARP funds 
provided to Citi would not hinge on Citi's ability to collect 
on one individual debt, but rather on Citi's ability to manage 
its credit and other risk exposures, which is where the Fed's 
supervision has and will continue to focus. We are currently in 
discussion with Citi as well as other recipients of TARP funds 
to determine the appropriateness of TARP repayment.

Q.25. In response to a question posed by Chairman Dodd, you 
stated you can give instances where the Fed's supervisory 
authority aided monetary policy. Please do so with as much 
detail as possible.

A.25. As a result of its supervisory activities, the Federal 
Reserve has substantial information and expertise regarding the 
functioning of banking institutions and the markets in which 
they operate. The benefits of this information and expertise 
for monetary policy have been particularly evident since the 
outbreak of the financial crisis. Over this period, supervisory 
expertise and information have helped the Federal Reserve to 
better understand the emerging pressures on financial firms and 
markets and to use monetary policy and other tools to respond 
to those pressures. This understanding contributed to more 
timely and decisive monetary policy actions. Supervisory 
information has also aided monetary policy in a number of 
historical episodes, such as the period of ``financial 
headwinds'' following the 1990-91 recession, when banking 
problems held back the economic recovery.
    Even more important than the assistance that supervisory 
authority provides monetary policy, in my view, is the 
complementarity between supervisory authority and the Federal 
Reserve's ability to promote financial stability. Our success 
in helping to stabilize the banking system in late 2008 and 
early 2009 depended heavily on the expertise and information 
gained from our supervisory role. In addition, supervisory 
expertise in structured finance contributed importantly to the 
design of the Commercial Paper Funding Facility, the Money 
Market Investor Funding Facility, and the Term Asset-Backed 
Securities Loan Facility, all of which have helped to stabilize 
broader financial markets. Historically, our ability to respond 
effectively to the financial disruptions associated with the 
September 11, 2001, terrorist attacks, to the 1987 stock market 
crash, as well as a number of other episodes, was greatly 
improved by our supervisory expertise, information, and 
authorities. At the same time, the Federal Reserve's unique 
expertise developed in the course of making monetary policy can 
be of great value in supervising complex financial firms.

Q.26. In response to a question posed by Chairman Dodd, you 
stated ``we do not see at this point any extreme mis-valuations 
of assets in the United States.'' Does that mean you believe 
the price of gold is not artificially inflated or out of line 
with fundamentals? If so, what does the rise in the gold price 
signify to you?

A.26. Gold is used for many purposes. It is an input into the 
production of electronics, automobiles, and jewelry; it is held 
as reserve asset by governments; and it represents an 
investment for private individuals. With fluctuations in the 
price of gold reflecting changes in demand associated with any 
of these uses, as well as changes in supply, it is extremely 
difficult to gauge whether or not price changes are consistent 
with fundamentals. The most recent increases in the price of 
gold likely reflect diverse influences, including investor 
concerns about the many uncertainties facing the global 
economy; however, it is also the case that the rise in gold 
prices has not been much out of line with the increases in 
other commodities. According to the Commodity Research Bureau, 
after fluctuating in a broad range for the previous 1\1/2\ 
years, the price of gold has risen 22 percent since early July, 
while the CRB's index of overall commodity prices has risen 17 
percent. These increases appear to reflect the recovery of the 
global economy, and it is not clear they have been out of line 
with fundamentals.

Q.27. In response to a question posed by Senator Johnson, you 
indicated your concern about the GAO possibly gaining access to 
``all the policy materials prepared by staff.'' What is your 
concern about Congress and the public having the same 
understanding of the issues surrounding monetary policy 
decisions as you and the rest of the Fed have?

A.27. I think it desirable and beneficial for Congress and the 
public to have the same understanding of issues surrounding 
monetary policy decisions that I and my colleagues on the FOMC 
have. To that end, we explain our policy decisions in frequent 
testimony and reports to Congress as well as in press releases, 
minutes, and speeches. In addition, the Federal Reserve makes a 
great deal of policy-related data and research material, 
including materials prepared by Federal Reserve staff, readily 
available to the Congress and the public. But, in order for the 
Federal Reserve staff to be able to provide its best policy 
analysis and advice to monetary policymakers, it is necessary 
for some staff analysis to be kept confidential for a period of 
time. If instead this material were turned over to the GAO, 
that could ultimately lead to political pressure being applied 
directly to the Federal Reserve's staff. Such pressure could 
lead the staff to omit more sensitive material from its policy 
analyses and more generally might cause the staff to skew its 
analyses and judgments. That outcome could have serious adverse 
effects on monetary policy decisions, to the detriment of the 
performance of our economy. Also, investors and the general 
public would likely perceive a requirement to turn confidential 
staff analyses over to the GAO as undermining the independence 
of monetary policy, potentially leading to some unanchoring of 
inflation expectations and thus reducing the Federal Reserve's 
ability to conduct monetary policy effectively.

Q.28. In response to a question posed by Senator Corker, you 
stated ``On the mortgage-backed securities, we have a 
longstanding authorization to do that. I do not think there is 
any legal issue.'' Please provide the Fed's legal analysis on 
the authority to purchase such securities, particularly those 
issued by Fannie Mae and Freddie Mac, which are not fullfaith-
and-credit obligations of the United States.

A.28. Section 14(b)(2) of the Federal Reserve Act (12 U.S.C. 
355) authorizes the Federal Reserve Banks, under the direction 
of the FOMC, to ``buy and sell in the open market any 
obligation which is a direct obligation of, or fully guaranteed 
as to principal and interest by, any agency of the United 
States.'' The Board's Regulation A (12 C.F.R. 201) has long 
defined the Federal National Mortgage Association (Fannie Mae), 
the Federal Home Loan Mortgage Corporation (Freddie Mac), and 
the Government National Mortgage Association (Ginnie Mae) as 
agencies of the United States for purposes of this paragraph. 
All mortgage-backed securities (MBS) acquired by the Federal 
Reserve in its open market operations are fully guaranteed as 
to principal and interest by Fannie Mae, Freddie Mac, and 
Ginnie Mae.

Q.29. In response to question posed by Senator Johanns 
regarding an exit strategy, you said ``The next step at some 
point, when the economy is strong enough and ready, will be to 
begin to tighten policy, which means raising interest rates. We 
can do that by raising the interest rate we pay on excess 
reserves. Congress gave us the power to pay interest on 
reserves that banks hold with the Fed. By raising that interest 
rate, we will be able to raise interest rates throughout the 
money markets.''
    In response to a written question I posed to you at the 
July 22 monetary policy hearing, you said the Fed at that time 
had no plans to switch to using the new interest on reserves 
power as the means of setting the policy rate. However, in your 
response to Senator Johanns you sound inclined to use the 
reserve interest rate as the policy rate. Is that correct, and 
if so, what has changed in the last few months?

A.29. In my written response to the question you posed on July 
22, I indicated that the Federal Reserve currently expects to 
continue to set a target (or a target range) for the Federal 
funds rate as part of its procedure for conducting monetary 
policy. We are already using the authority that the Congress 
provided to pay interest on reserve balances, and we anticipate 
continuing to use that authority in the future. For example, 
when the time is appropriate to begin to firm the stance of 
monetary policy, the Federal Reserve could increase its target 
for the Federal funds rate. As I indicated in my response to 
Senator Johanns, the Federal Reserve could affect the increase 
in the Federal funds rate partly by increasing the interest 
rate that it pays on reserves. The Federal Reserve also has a 
number of additional tools for managing the supply of bank 
reserves and the Federal funds rate, and these tools could be 
used in conjunction with the payment of higher rates of 
interest on reserves.

Q.30. In response to a question posed by Senator Gregg, you 
stated ``it would be worthwhile to consider, for example, 
whether regulators might prohibit certain activities. If a 
financial institution cannot demonstrate that it can safely 
manage the risks of a particular type of activity, for example, 
then it could be scaled back or otherwise addressed by the 
regulator.'' Do you have examples of such activities in mind? 
Are there some activities that we should prohibit banks or 
other financial institutions from engaging in outright?

A.30. Congress traditionally has sought to limit the ability of 
insured depository institutions to engage, directly or through 
a subsidiary, in potentially risky activities. Therefore, 
banking supervisors have emphasized safety and soundness, 
banking organizations' management of risks associated with 
their activities, and the adequacy of their capital to support 
those risks. In that regard, the Federal Reserve has the 
authority to take a series of actions to ensure that bank 
holding companies and State member banks operate in a safe and 
sound manner.
    As evidenced by the recent subprime lending crisis, even 
traditional banking activities such as lending may pose 
significant risks if not safely managed. These activities do 
not lend themselves to general prohibitions, but rather to 
institution-specific consideration. The Federal Reserve 
considers whether a banking organization can effectively manage 
the risk of its regular or proposed activities through its 
ongoing supervisory process as well as its analysis of 
proposals to engage in new activities. Going forward, the 
Federal Reserve will continue to consider actions under our 
authority to restrict any activities that present safety and 
soundness concerns. Such actions that we might take include, 
but are not limited to:

    Imposing higher capital requirements to address 
        weaknesses in asset quality, credit administration, 
        risk management, or other elevated levels of risk 
        associated with an activity;

    Requiring a banking organization to make more 
        detailed and comprehensive public disclosures regarding 
        a particular activity;

    Exercising our enforcement authority to limit the 
        overall nature or performance of an activity, such as 
        by imposing concentrations limits; and

    Issuing cease and desist orders to correct unsafe 
        or unsound practices.

Q.31. In response to a question posed by Senator Corker, you 
mentioned you could provide more detail about problems at the 
Fed and the actions you are taking to correct them. What 
specific shortcomings have you identified and what specific 
steps have you taken to address them?

A.31. The financial crisis was the product of fundamental 
weaknesses in both private market discipline and government 
supervision and regulation of financial institutions. 
Substantial risk management weaknesses led to financial firms 
not recognizing the nature and magnitude of the risks to which 
they were exposed. Neither market discipline nor government 
regulation prevented financial institutions from becoming 
excessively leveraged or otherwise taking on excessive risks. 
Within the United States, every Federal regulator with primary 
responsibility for prudential supervision and regulation of 
large financial institutions saw firms for which it was 
responsible approach failure.
    At the Federal Reserve, we have extensively reviewed our 
performance and moved to strengthen our oversight of banks. We 
have led internationally coordinated efforts to tighten 
regulations to help constrain excessive risk taking and enhance 
the ability of banks to withstand financial stress through 
improved capital and liquidity standards. We are building on 
the success of the Supervisory Capital Assessment Program (the 
``stress tests'') to reorient our approach to large, 
interconnected banking organizations to incorporate a more 
``macroprudential'' approach to supervision. As such, we are 
expanding our use of simultaneous and comparative cross-firm 
examinations, and drawing on a range of disciplines--
economists, market experts, accountants and lawyers--from 
across the Federal Reserve System. We are also complementing 
our traditional on-site examinations with enhanced off-site 
surveillance programs, under which multi-disciplinary teams 
will combine supervisory information, firm-specific data 
analysis, and market-based indicators to identify emerging 
issues.

Q.32. What was your role in including in the TARP proposal the 
ability to purchase ``any other financial instrument''? Was 
inclusion of such a provision your suggestion?

A.32. Apart from stating the need for it, I was not involved in 
the negotiations between the Administration and the Congress on 
the terms of the TARP. However, the flexibility afforded the 
TARP to purchase financial instruments as needed to promote 
financial stability proved crucial in allowing a rapid response 
to the quickly deteriorating financial conditions in October 
2008.

Q.33. What was your role in the decision to make capital 
investments rather than toxic asset purchases with TARP funds?

A.33. It became apparent in October 2008 that the plan to 
purchase toxic assets was likely to take some months to 
implement and would not be available in time to arrest the 
escalating global crisis. Following the approach used in a 
number of other industrial countries, the Treasury made capital 
available instead to help stabilize the banking system. The 
Treasury consulted closely with the Federal Reserve on this 
decision.

Q.34. As a general matter I do not think the Fed Chairman 
should comment on tax or fiscal policy, so please respond to 
this from the perspective of bank supervision and not fiscal 
policy. Are there any provisions of the tax code that unwisely 
distort financial institutions' behavior that Congress should 
consider as part of financial regulatory reform? For example, 
the tax code allows deductions for the interest paid on debt, 
which may cause firms to favor debt over equity. Do you have 
concerns about that provision? Are there other provisions that 
influence companies' behavior that concern you?

A.34. The taxation of businesses and households is a 
fundamental part of fiscal policy. I have avoided taking a 
position on explicit tax policies and budget issues during my 
tenure as Chairman of the Federal Reserve Board. I believe that 
these are decisions that must be made by the Congress, the 
Administration, and the American people. Instead I have 
attempted to articulate the principles that I believe most 
economists would agree are important for the long-term 
performance of the economy and for helping fiscal policy to 
contribute as much as possible to that performance. In that 
regard, tax revenues should be sufficient to adequately cover 
government spending over the longer-term in order to avoid the 
economic costs and risks associated with persistently large 
Federal deficits. But the choices that are made regarding both 
the size and structure of the Federal tax system will affect a 
wide range of economic incentives that will be part of 
determining the future economic performance of our Nation.
    In assessing the lessons of the recent financial crisis, it 
is difficult to find evidence that the tax treatment of 
financial institutions played a role in the problems that 
developed. In particular, the tax structure faced by these 
institutions did not change prior to the onset of these 
problems and did not appear to be associated with the buildup 
of leverage and risk taking that occurred. The more important 
remedial steps must be taken in the regulatory sphere, and I 
have outlined a comprehensive program aimed at ensuring that a 
crisis of this kind does not recur.

Q.35. Do you think a cap on bank liabilities is appropriate? 
For example, do you think limiting a bank's liabilities to 2 
percent of GDP is a good idea?

A.35. In the policy debate about how best to control the 
systemic risk posed by very large firms, restriction on size is 
one of the solutions being discussed. However, a cap on a 
bank's liabilities linked to a measure such as GDP may not be 
appropriate. In pursuing a size restriction, policymakers would 
need to carefully analyze the metric that was used as the basis 
for the restriction to ensure that limits on lines of business 
reflect the risks the activities present. Broadbased caps 
applied without such analysis potentially could limit the 
banking system's ability to support economic activity.

Q.36. AIG still has obligations to post collateral on swaps 
still in force. Will the Fed post collateral if the 
deteriorating credit conditions at AIG or general credit market 
issues require it?

A.36. No. The Federal Reserve can only lend to borrowers on a 
secured basis; the Federal Reserve cannot post its own assets 
as collateral for a third party. AIG is obligated to continue 
to post collateral as required under the terms of its 
derivatives contracts with its counterparties. AIG may borrow 
from the revolving credit facility with the Federal Reserve to 
meets its obligations as they come due, including to meet 
collateral calls on its derivative contracts. AIG itself is 
obligated to repay all advances under the revolving credit 
facility, which is fully secured by assets of AIG, including 
the shares of substantially all of AIG's subsidiaries.

Q.37. If TARP and other bailout actions were necessary because 
the largest financial firms were too big to fail, why have the 
largest few institutions actually been allowed to grow bigger 
than they were before the bailouts? Does it concern you that 
those few institutions write approximately half the mortgages, 
issue approximately two-thirds of the credit cards, and control 
approximately 40 percent of deposits in this country?

A.37. I am concerned about the potential costs to the financial 
system and the economy of institutions that are perceived as 
too big to fail. To address these costs, I have detailed an 
agenda for a financial regulatory system that ensures 
systemically important institutions are subject to effective 
consolidated supervision, that a more macroprudential outlook 
is incorporated into the regulatory and supervisory framework, 
and that a new resolution process is created that would allow 
the government to wind down such institutions in an orderly 
manner. In addition, high concentrations might raise antitrust 
concerns that consumers would be harmed from lack of 
competition in certain financial products. For this reason, 
antitrust enforcement by bank regulators and the Department of 
Justice would preclude mergers that are considered likely to 
have significant adverse effects on competition.

Q.38. On May 5, 2009, in front of the Joint Economic Committee, 
you said the following about the unemployment rate: 
``Currently, we don't think it will get to 10 percent. Our 
current number is somewhere in the 9s.'' In November it hit 
10.2 percent, and many economists predict it will go even 
higher. This is happening despite enormous fiscal and monetary 
stimulus that you previously said would help create jobs. What 
happened after your JEC testimony in May that caused your 
prediction to miss the mark?

A.38. At the time of my testimony before the JEC, the central 
tendency of the projections made by FOMC participants was for 
real GDP to fall between 1.3 and 2.0 percent over the four 
quarters of 2009 and for the unemployment rate to average 
between 9.2 and 9.6 percent in the fourth quarter. As it turned 
out, we were too pessimistic about the overall decline in real 
GDP this year and too optimistic about the extent of the rise 
in the unemployment rate. Although we indicated in the minutes 
from the April FOMC meeting that we saw the risks to the 
unemployment rate as tilted to the upside, we underestimated 
the extent to which employers were able to continue to reduce 
their work forces even after they began to increase production 
again. These additional job reductions have contributed to 
surprisingly large gains in productivity in recent quarters and 
to the unexpectedly steep rise in the unemployment rate.

Q.39. In his questioning at your hearing, Senator DeMint 
mentioned several of your predictions about the economy that 
proved inaccurate. For example:

    March 28, 2007: ``The impact on the broader economy 
        and financial markets of the problems in the subprime 
        markets seems likely to be contained.''

    May 17, 2007: ``We do not expect significant 
        spillovers from the subprime market to the rest of the 
        economy or to the financial system.''

    Feb. 28, 2008, on the potential for bank failures: 
        ``Among the largest banks, the capital ratios remain 
        good and I don't expect any serious problems of that 
        sort among the large, internationally active banks that 
        make up a very substantial part of our banking 
        system.''

    June 9, 2008: ``The risk that the economy has 
        entered a substantial downturn appears to have 
        diminished over the past month or so.''

    July 16, 2008: Fannie Mae and Freddie Mac are 
        ``adequately capitalized'' and ``in no danger of 
        failing.''

    I do not bring these up to criticize you for making 
mistakes. Rather, it is important to examine the reason for 
mistakes to learn from them and do better in the future. Have 
you or the Fed examined why those predictions were wrong? Have 
you or the Fed changed anything such as your models, forecasts, 
or data sets as a result? What has the Fed done to revamp its 
analytical framework to better anticipate potential 
macroeconomic problems?

A.39. The principal cause of the financial crisis and economic 
slowdown was the collapse of the global credit boom and the 
ensuing problems at financial institutions. Financial 
institutions suffered directly from losses on loans and 
securities on their balance sheets, but also from exposures to 
off-balance sheet conduits and to other financial institutions 
that financed their holdings of securities in the wholesale 
money markets. The tight network of relationships between 
regulated financial firms with these other institutions and 
conduits, and the severity of the feedback effects between the 
financial sector and the real economy were not fully understood 
by regulators or investors, either here or abroad. Our failure 
to anticipate the full severity of the crisis, particularly its 
intensification in the fall of 2008, was the primary reason for 
the forecasting errors cited by Senator DeMint.
    We also are expanding our use of forward-looking aggregate 
macroeconomic scenario analysis in supervisory practices to 
enhance our understanding of the consequences of changes in the 
economy for individual firms and the broader financial system. 
In addition, we are conducting research to augment our 
macroeconomic forecasting tools to incorporate more refined 
channels by which information on possible financial market 
stresses would feed back to the macroeconomy.

Q.40. Derivatives such as credit-default swaps played an 
important role in the financial crisis, and they are central to 
the financial reforms currently being contemplated. During the 
Senate Banking Committee's hearing in November 2005 to confirm 
you as Alan Greenspan's successor, you had the following 
exchange with Senator Paul Sarbanes:

        SARBANES: Warren Buffett has warned us that derivatives 
        are time bombs, both for the parties that deal in them 
        and the economic system. The Financial Times has said 
        so far, there has been no explosion, but the risks of 
        this fast growing market remain real. How do you 
        respond to these concerns?

        BERNANKE: I am more sanguine about derivatives than the 
        position you have just suggested. I think, generally 
        speaking, they are very valuable. They provide methods 
        by which risks can be shared, sliced, and diced, and 
        given to those most willing to bear them. They add, I 
        believe, to the flexibility of the financial system in 
        many different ways. With respect to their safety, 
        derivatives, for the most part, are traded among very 
        sophisticated financial institutions and individuals 
        who have considerable incentive to understand them and 
        to use them properly. The Federal Reserve's 
        responsibility is to make sure that the institutions it 
        regulates have good systems and good procedures for 
        ensuring that their derivatives portfolios are well 
        managed and do not create excessive risk in their 
        institutions.

    Do you still agree with that statement? If not, why do you 
think you were wrong?

A.40. I continue to believe that OTC derivative instruments are 
valuable tools for the management of risk and that they are an 
important part of our financial markets. Events of the last 2 
years have demonstrated, however, that there were significant 
weaknesses in the risk management systems and procedures for 
these derivatives at some market participants and that 
supervisors did not fully appreciate the interconnections among 
regulated dealers and their unregulated counterparties that 
magnified these weaknesses. Supervisors have recognized that 
financial institutions must make changes in their risk-
management practices for OTC derivatives by improving internal 
processes and controls and by ensuring that adequate credit 
risk-management disciplines are in place for complex products, 
regardless of the form they take. Efforts are under way to 
improve collateralization practices to limit counterparty 
credit risk exposures and to strengthen the capital regime. 
Regulators both in the United States and abroad also are 
speeding the development of central counterparties (CCPs) that 
offer clearing services for some OTC derivative contracts. 
These CCPs offer financial institutions another tool for 
managing the counterparty credit risk that arises from OTC 
derivatives.

Q.41. An important factor in the financial crisis (and a large 
part of the ultimate cost to taxpayers) was the implicit 
government guarantee of the GSEs. In part because of decisions 
you made, there is now an explicit government guarantee of 
every large firm on Wall Street. Has moral hazard increased or 
decreased over the past year?

A.41. The actions by Treasury, the Federal Deposit Insurance 
Corporation, and the Federal Reserve were taken to stabilize 
financial markets during a time of unprecedented turmoil. These 
actions mitigated the effect of financial market turmoil on the 
U.S. economy more generally. Moral hazard has been, and 
continues to be, a significant concern with respect to large 
financial institutions. The Secretary of the Treasury has 
proposed significant reforms that include enhanced supervision 
of systemically important financial firms, a focus on 
macroprudential supervision and new resolution authority over 
systemically important financial firms. These reforms would 
mitigate moral hazard and I strongly support them.

Q.42. Via the FDIC, the American public now explicitly 
guarantees the bonds of Wall Street firms where bonuses are 
surging and individual employees can be paid millions of 
dollars a year. What is your opinion on the morality of this 
guarantee?

A.42. The Federal Deposit Insurance Corporation's Temporary 
Liquidity Guarantee Program (TGLP) is one of many necessary 
actions taken to stabilize financial markets during a time of 
unprecedented financial stress. These actions helped support 
the flow of credit and mitigated the most severe potential 
effects of the turmoil on the economy. Many households and 
businesses benefited from these guarantees. These and similar 
actions were taken with the sole objective of better achieving 
the mandate given to us by the Congress, namely (for the FDIC) 
to mitigate serious systemic risks and (for the Federal 
Reserve) to promote financial stability, price stability, and 
maximum employment. Hence, they were justified--indeed 
necessary and appropriate under our Congressional mandate.

Q.43. The importance you place on the output gap is well known. 
You have often cited ``excess slack'' in the economy to justify 
loose monetary policy, arguing that a large output gap lowers 
the risk of inflation. But economists such as Allan Meltzer 
have noted that there are ``lots of examples of countries with 
underutilized resources and high inflation. Brazil in the 1970s 
and 1980s.'' Moreover, in a new paper dated December 2009 and 
titled ``Has the Recent Real Estate Bubble Biased the Output 
Gap?'', researchers at the Federal Reserve Bank of St. Louis 
state ``Because this (predicted) output gap is so large, 
several analysts have concluded that monetary policy can remain 
very accommodative without fear of inflationary repercussions. 
We argue instead that standard output gap measures may be 
severely biased by the bubble in real estate prices that, 
according to many, started around 2002 and burst in 2007.'' 
They conclude with a warning: ``We offer a word of caution to 
policymakers: Policies based on point estimates of the output 
gap may not rest on solid ground.'' Please comment on (1) Allan 
Meltzer's point and (2) the St. Louis Fed's research paper. Why 
do you continue to put such a high priority on the output gap?

A.43. I do find the evidence compelling that resource slack, as 
measured by an output or unemployment gap, is one factor that 
influences inflation. But it is not the only such factor, and 
Allan Meltzer is correct that there have been examples of 
underutilized resources coinciding with high or rising 
inflation. This was the case in the United States in the 1970s, 
for example, when large increases in the price of imported oil 
both raised inflation and held down production. Furthermore, 
estimates of the output gap are inherently uncertain, and I 
agree that it is important to keep that uncertainty in mind 
when we make decisions about monetary policy. Some estimates, 
such as the one you cite from researchers at the St. Louis Fed, 
suggest that the output gap is not large at present. However, 
the bulk of the evidence indicates that resource slack is now 
substantial, as evidenced by an unemployment rate of 10 percent 
and a rate of manufacturing capacity utilization of only 68 
percent--lower than seen at the trough of every postwar 
recession prior to the current one. Thus, I continue to expect 
slack resources, together with the stability of inflation 
expectations, to contribute to the maintenance of low inflation 
in the period ahead.

Q.44. In a scenario in which unemployment remains uncomfortably 
high, but the dollar continues to fall and commodities 
including oil and gold continue to rise, what would the Fed do? 
At what point do market signals take priority over hard-to-
measure statistics like the output gap?

A.44. The output gap is only one of many economic signals, 
including a broad array of economic data and market indicators, 
that the FOMC consults in setting policy. It is difficult to 
predict what actions the FOMC would take in some future 
situation. Certainly it would be mindful of its dual mandate to 
foster price stability and maximum sustainable employment. If 
declines in the dollar and increases in commodity prices were 
creating upward pressures on consumer prices and causing 
expectations of future inflation to rise, those developments 
would be taken extremely seriously by the Committee, and would 
have to be balanced against the high rate of unemployment that 
you posit in your hypothetical. But the clear lesson from the 
experience of the 1970s and from that of other countries is the 
high cost that a nation pays in terms of macroeconomic 
performance when it loses sight of the importance of 
maintaining a credible plan for the achievement of price 
stability and maximum sustainable employment in the medium and 
longer terms.

Q.45. The Fed has a dual mandate: maximum employment and price 
stability. But unemployment is at its highest level in decades. 
And in early and mid-2008, with oil at $150 a barrel and prices 
of basic staples skyrocketing, opinion polls showed that 
inflation was the public's highest concern, even more so than 
jobs or the housing market. Why has the Fed failed so badly in 
its mandate? Is employment an appropriate objective for 
monetary policy? Should the Fed have a single mandate of price 
stability?

A.45. The Federal Reserve's performance should be judged in 
terms of the extent to which its policies have fostered 
satisfactory outcomes for economic activity and inflation given 
the unanticipated shocks that have occurred. For example, while 
U.S. consumer price inflation was temporarily elevated by 
shocks to the prices of energy and other commodities during 
early and mid-2008 and then dropped sharply after the 
intensification of the global financial crisis, the Federal 
Reserve's policies have been successful in keeping the longer-
term inflation expectations of households and businesses firmly 
anchored throughout this period. Moreover, while the financial 
crisis led to a severe economic contraction and a steep rise in 
unemployment, the Federal Reserve's extraordinary policy 
measures have been crucial in averting a global financial 
collapse that would have been associated with far higher rates 
of unemployment.
    I support the Federal Reserve's dual mandate of maximum 
employment and price stability. These congressionally mandated 
goals are appropriate and generally complementary, because 
price stability helps moderate the short-term variability of 
employment and contributes to the economy's employment 
prospects over the longer run. Under some circumstances, 
however, there may indeed be a temporary trade-off between the 
elements of the dual mandate. For example, an adverse supply 
shock might cause inflation to be temporarily elevated at the 
same time that employment falls below its maximum sustainable 
level. In such a situation, a central bank that focused 
exclusively on bringing inflation down as quickly as possible 
might well exacerbate the economic weakness, whereas a monetary 
policy strategy consistent with the Federal Reserve's dual 
mandate would aim to foster a return to price stability at a 
lower cost in terms of lost employment.

Q.46. In February 2009, Janet Yellen, president of the San 
Francisco Fed, said that the Fed needed to fight back against 
the argument that its liquidity efforts would eventually lead 
to higher inflation and higher interest rates, calling the 
notion ``ludicrous.'' Since then, the dollar has fallen 
precipitously, oil has almost doubled in price, and gold has 
surged to all-time highs. Do you share your colleague's view on 
inflation?

A.46. The dollar serves as an international reserve currency; 
hence, short-term fluctuations in the foreign exchange value of 
the dollar are often linked to global developments rather than 
to U.S. monetary policy or inflation. Indeed, the 
intensification of the global economic and financial crisis in 
the second half of 2008 was associated with a substantial rise 
in the foreign exchange value of the dollar as investors 
increased their holdings of relatively safe dollar-denominated 
assets. As financial markets have recovered this year and the 
world economy has stabilized, that appreciation has gradually 
unwound and the foreign exchange value of the dollar has 
essentially returned to its level prior to the events of the 
fall of 2008. The prices of energy and other commodities are 
also closely linked to global economic developments; for 
example, the spot price for West Texas intermediate crude oil 
dropped sharply from around $130 per barrel in July 2008 to 
around $40 per barrel at the turn of the year, but it has 
subsequently rebounded to about $75 per barrel as the global 
economic outlook has improved. The Commodity Research Bureau's 
index of overall commodity prices indicates that the rise in 
the price of gold over the past few months is in line with the 
increased prices of other commodities over the same period.
    I do not believe that the Federal Reserve's credit and 
liquidity programs will lead to higher inflation. Longer-term 
inflation expectations appear stable, and as I have emphasized 
in the past, the Federal Reserve has the tools it needs to 
withdraw the current substantial degree of monetary policy 
stimulus when it is appropriate to do so. The Federal Reserve 
will adjust the stance of policy as needed to fulfill its dual 
mandate of fostering price stability and maximum employment.

Q.47. What does the surge in gold mean to you? At what price 
level would it begin to worry you, if it doesn't already? Does 
gold have any impact on the Fed's policy deliberations?

A.47. As mentioned in response to questions #6 and #26, gold is 
used for many purposes. Movements in the price of gold are 
determined by changes in the demand for gold for its various 
uses and changes in supply conditions. Therefore, assessing why 
gold prices have recently risen and whether the increase is 
consistent with fundamentals is very difficult. Accordingly, it 
is also difficult to specify a particular level of the price of 
gold which, if exceeded, would indicate particularly worrisome 
developments. As also mentioned earlier, the Federal Reserve 
looks at a wide array of indicators of market sentiment and 
inflation expectations. Among those indicators is the price of 
gold, but for the reasons just noted, its movements are often 
harder to interpret than those of some of the other indicators. 
Nonetheless, we will continue to monitor the price of gold 
going forward.

Q.48. Why does the Fed insist on waiting 5 years before it 
releases transcripts of FOMC meetings to the public?

A.48. The effectiveness of monetary policy deliberations is 
facilitated by the policy of maintaining the confidentiality of 
FOMC meeting transcripts for 5 years, so that participants can 
have a candid and free exchange of views about alternative 
policy approaches. It is noteworthy that the 5-year interval 
prior to publication of FOMC meeting transcripts is much 
shorter than required under the Federal Records Act, which 
directs such records to be transmitted to the National Archives 
and made public after a 30-year period. Moreover, from an 
international perspective, the Federal Reserve is virtually 
unique with regard to this aspect of its transparency; no other 
major central bank publishes transcripts of its monetary policy 
meetings.

Q.49. Has the Fed ever had an internal debate about how 
monetary policy contributes to geopolitical tensions via the 
rising oil prices caused by a falling dollar?

A.49. Monetary policy may exert some effect on oil prices 
through a number of channels, including: the cost of carrying 
inventories and of investing in productive capacity, the pace 
of economic growth, and the exchange rate. However, the effects 
of changes in interest rates and exchange rates on oil prices 
appear to be relatively small. Accordingly, my sense is that 
variations in monetary policy have played only a limited role 
in the wide swings in oil prices observed in recent years.

Q.50. Before the financial crisis there was a widespread sense, 
especially on Wall Street trading desks, that the stock market 
was strangely resilient. This encouraged excessive risk-taking 
in various types of assets. Do you have direct or indirect 
knowledge of the Federal Reserve or any government entity or 
proxy ever intervening to support the stock market (or any 
individual stock) via futures or in any other way? If yes, who 
decides the timing of such intervention and with what criteria? 
How is it funded? Which Wall Street firm handles the orders, 
and who sees them before they are executed?

A.50. The Federal Reserve has not intervened to provide support 
to the stock market or individual stocks by trading in futures 
or any other financial instrument. I have no knowledge of any 
other U.S. government entity providing such support.

Q.51. You have repeatedly stated your concern that an audit of 
the Fed will undermine the independence of the Fed in monetary 
policy. What do you fear influence from Congress will lead to, 
tighter or looser policy?

A.51. Broadening the scope of the GAO to include a review of 
monetary policy functions would undermine the safeguards that 
Congress put in place in 1978 to promote monetary policy 
independence and insulate the Federal Reserve from short-run 
political pressures. As a result, households, businesses, and 
investors might well conclude that the Federal Reserve would 
not be in a position to combat inflation pressures as 
effectively as in the past. This loss of confidence could lead 
to higher inflation expectations, hence boosting interest rates 
and raising the cost of credit for households and businesses. 
Moreover, inflation expectations would be more likely to rise 
in response to monetary policy accommodation undertaken to 
address high unemployment and weak economic activity. This 
potentially greater sensitivity of inflation expectations to 
accommodative monetary policy could limit the Federal Reserve's 
ability to combat high unemployment and economic weakness 
without an undesirable boost in inflation.

Q.52. Do you believe our banking system is facing a future like 
Japan's system faced in the 1990s, with zombie banks as an 
obstacle to economic prosperity? Why or why not?

A.52. I do not believe that the U.S. banking system is facing a 
future akin to that of Japanese banks in the 1990s. Japanese 
authorities took a long time to take the steps that were 
necessary to deal with zombie banks and ensure a sound banking 
system, because they first had to construct a strong system of 
bank supervision and regulation. It wasn't until the late 1990s 
that new laws were passed to deal with bank insolvencies and 
the Financial Supervisory Agency, which later became the 
Financial Services Agency (FSA), was established. And it was 
not until 2002 that the FSA conducted its first round of 
examinations of major banks aimed at ensuring that they were 
adequately identifying and provisioning against nonperforming 
loans.
    In contrast, U.S. authorities, including the Federal 
Reserve, have been able to quite rapidly take strong steps to 
address bank weakness. First, the Commercial Bank Examination 
Manual and the Bank Holding Company Supervision Manual have 
long contained guidance for bank and bank holding company (BHC) 
examiners on evaluating the adequacy of loan loss reserves, and 
examiners continue to follow this guidance. In addition, 
earlier this year, the Federal Reserve and other Federal bank 
supervisors completed a comprehensive forward-looking capital 
assessment exercise--the Supervisory Capital Assessment Program 
(SCAP)--on the largest 19 U.S. BHCs. This exercise went further 
than a regular BHC examination (which produces a snapshot of 
current BHC health), because it involved estimating losses that 
might arise over a period of 2 years under more-adverse-than-
expected economic assumptions, and because it ensured 
consistency across institutions.

Q.53. Do you believe the Fed's policies are enabling banks to 
put off recognizing their losses?

A.53. The Federal Reserve's policies are not enabling banks to 
defer recognizing incurred loan losses or overstating income. 
We require institutions to prepare regulatory reports in 
accordance with generally accepted accounting principles 
(GAAP). Currently, GAAP requires estimated incurred loan losses 
to be recognized in the financial statements. We have issued 
numerous reminders in the form of supervisory guidance that 
reiterate the need for institutions to take appropriate loan 
losses. Most recently, we issued guidance on commercial real 
estate lending that encouraged institutions to work with 
borrowers while reiterating the importance of recognizing loan 
losses on restructured loans as appropriate. By no means have 
we been suggesting any type of forbearance on loan loss 
recognition. However, we believe that the accounting loan loss 
model needs to be modified to improve recognition of credit 
losses.

Q.54. What was your rationale for letting Lehman fail?

A.54. Concerted government attempts to find a buyer for Lehman 
Brothers or to develop an industry solution proved 
unsuccessful. Moreover, providers of both secured and unsecured 
credit to the company were rapidly pulling away from the 
company and the company needed funding well above the amount 
that could be provided on a secured basis. As you know, the 
Federal Reserve cannot make an unsecured loan. Because the 
ability to provide capital to the institution had not yet been 
authorized under the Emergency Economic Stabilization Act, the 
firm's failure was, unfortunately, unavoidable. The Lehman 
situation is a clear example of why the government needs the 
ability to wind down a large, interconnected firm in an orderly 
way that both mitigates the costs on society as whole and 
imposes losses on the shareholders and creditors of the failing 
firm.

Q.55. Reportedly, the Fed is requiring banks to report their 
derivatives positions to the Fed. Does the Fed have the 
expertise and analytical capacity to understand and act on that 
information?

A.55. Yes. The Federal Reserve has staff members with both 
financial economics and financial analysis expertise. These 
staff members contribute both to the analysis of financial data 
at the macro or market level and to the understanding of models 
used by individual institutions in their derivatives 
activities.

Q.56. Given that some economic conditions have worsened beyond 
what was assumed in the ``stress tests'' earlier this year, do 
you still believe the stress tests to be useful or accurate 
representations of the institutions examined?

A.56. I believe that the stress tests are still a useful 
representation of the risks of the examined institutions in a 
more stressful environment than expected. It is true that since 
the scenarios for the stress tests were specified, the 
unemployment rate has risen sharply and will be above the rate 
that was assumed for 2009 in the more adverse scenario. 
However, the latest private forecasts indicate that the 
unemployment rate next year will be noticeably below the rate 
assumed in the more adverse scenario, and the rebound in real 
GDP next year will be larger than was assumed. Further, 
incoming data on house prices have been considerably better 
than expected, which should reduce losses, and a significant 
part of the estimated losses in the stress tests at the 
examined institutions were related to the substantially lower 
house prices assumed in the more adverse scenario.

Q.57. In your recent Washington Post op-ed, you recognized that 
the Fed ``did not do all that it could have'' under your 
leadership to prevent the financial crisis, why should the 
public have any confidence that the next time the Fed will do 
all it can?

A.57. The regulatory framework that was in place at the onset 
of the crisis had not kept pace with dramatic changes in the 
structure and activities of the financial sector. Specifically, 
U.S. and global regulations did not adequately address the 
possibility of significant losses in the trading book, 
securitizations, and some other capital market activities that 
had become a significant feature of the financial system. The 
Federal Reserve has already taken steps, working with domestic 
supervisors and the Basel Committee on Bank Supervision, to 
increase capital requirements for trading activities and 
securitization exposures. The Federal Reserve is moving toward 
agreement with international counterparts on measures to 
improve the quality of capital, with a particular emphasis on 
the importance of common equity. We are also discussing options 
under which systemically important firms could supplement their 
capital base in times of stress through instruments that, for 
example, would trigger conversion into common equity when 
economic conditions or a firm's individual condition had 
weakened substantially. In addition, we are implementing 
strengthened guidance on liquidity risk management to better 
capture the complex financing characteristics of large, 
wholesale funded institutions, and are weighing proposals for 
quantitatively based requirements. It is important to couple 
these enhancements with legislative action to redress gaps in 
the regulatory framework by, for example, extending the 
perimeter of regulation to ensure that firms like AIG and 
Lehman Brothers are subject to robust consolidated supervision.

Q.58. Are you concerned that the debt to GDP ratio in this 
country is more than 350 percent? Do you believe a high debt to 
GDP ratio is reason for tightening Fed policy? Why or why not?

A.58. The current ratio of public and private debt to GDP, 
including not only the debt of the nonfinancial sector but also 
the debt of the financial sector, is about 350 percent. (Many 
analysts prefer to focus on the debt of the nonfinancial 
sectors because, they argue, the debt of the financial sector 
involves some double-counting--for example, when a finance 
company funds the loans it provides to nonfinancial companies 
by issuing bonds. The ratio of total nonfinancial debt to GDP 
is about 240 percent.) Private debt has been declining as 
households and firms have been reducing spending and paying 
down pre-existing obligations. For example, households, who are 
trying to repair their balance sheets, reduced their 
outstanding debt by 1.3 percent (not at an annual rate) during 
the first three quarters of this year.
    In contrast, public debt is growing rapidly. Putting fiscal 
policy on a sustainable trajectory is essential for promoting 
long-run economic growth and stability. Currently, the ratio of 
Federal debt to GDP is increasing significantly, and those 
increases cannot continue indefinitely. The increases owe 
partly to cyclical and other temporary factors, but they also 
reflect a structural Federal budget deficit. Stabilizing the 
debt to GDP ratio at a moderate level will require policy 
actions by the Congress to bring Federal revenues and outlays 
into closer alignment in coming years. The ratio of government 
debt to GDP does not have a direct bearing on the appropriate 
stance of monetary policy. Rather, the stance of monetary 
policy is appropriately set in light of the outlook for real 
activity and inflation and the relationship of that outlook to 
the Federal Reserve's statutory objectives of maximum 
employment and price stability. Of course, government 
indebtedness may exert an indirect influence on monetary policy 
through its potential implications for the level of interest 
rates consistent with full employment and low inflation. But in 
that respect, fiscal policy is just one of the many factors 
that influence interest rates and the economic outlook.

Q.59. The FDIC is seeing significant losses on the mortgages of 
failed banks. Why shouldn't we assume the Fed will see similar 
losses on the mortgages on the Fed's balance sheet? How is the 
Fed valuing those assets?

A.59. In conducting open market operations to support the 
availability of mortgage financing to households, the Federal 
Reserve has purchased only mortgage-backed securities (MBS) 
that are fully guaranteed as to principal and interest by 
Fannie Mae, Freddie Mac, and Ginnie Mae; accordingly, the 
Federal Reserve has no exposure to credit losses on the 
mortgages that underlie these MBS. Each week, the Federal 
Reserve publishes, in its H.4.1 statistical release, the 
current value of these securities, measured as the remaining 
principal balance on the underlying mortgages. The Federal 
Reserve also reports, in the Monthly Report on Credit and 
Liquidity Programs and the Balance Sheet, the end-of-month fair 
market value of these MBS. The fair market value is determined 
using market values obtained from an independent pricing 
vendor.
    The Federal Reserve also holds mortgage loans, MBS, and 
collateralized debt obligations that are backed by mortgage-
related assets through Maiden Lane LLC, Maiden Lane II LLC, and 
Maiden Lane III LLC. At the end of each quarter, the assets of 
these entities are revalued and the fair value of the assets is 
reported in the H.4.1 statistical release and in the Monthly 
Report on Credit and Liquidity Programs and the Balance Sheet. 
As explained in the Appendix to the Monthly Report, because of 
the mix of assets held by these entities, the terms on which 
the Federal Reserve acquired these assets, the equity or 
subordinated debt positions in these entities held by others, 
and the longer term nature of these facilities (which allows 
the assets to be held to maturity or sold as markets stabilize 
and asset values recover), the Board does not anticipate that 
the Federal Reserve or taxpayers will incur any net loss on the 
Federal Reserve's loans to these entities.

Q.60. I am concerned about the falling value of the dollar. 
China has disclosed that it has taken as much as a $350 billion 
loss on its dollar holdings since March, and believes it may 
take another $220 billion should the dollar fall a further 10 
percent. Under what scenario do you see China continuing to buy 
our debt when your actions, along with Treasury's, wipe out 
half a trillion dollars of value in the assets purchased from 
us?

A.60. Since March, the value of China's dollar holdings as 
measured in its own currency has not been affected by 
fluctuations in the U.S. dollar against other currencies, 
because operations by Chinese authorities in their foreign 
exchange markets have kept the value of the renminbi 
essentially unchanged against the U.S. dollar over this period. 
The cited losses of $350 billion may represent the gains China 
would have recorded had all of its foreign holdings been in 
currencies other than the dollar, but this is a hypothetical 
measure of foregone value rather than a realized loss, and, in 
any event, would just offset gains recorded as the dollar rose 
between the summer of 2008 and March 2009.
    Absent a policy shift in China that entails a 
discontinuation of official operations to resist upward 
pressure on the country's currency, China will continue to 
accumulate external assets and thus likely will continue to 
invest in U.S. assets. In fact, China has continued to purchase 
U.S. Treasuries in recent months. More generally, U.S. balance 
of payments data show that purchases of Treasury securities 
this year by all foreign official entities have been sizable, 
even during times when the dollar moved lower. Foreign 
countries, including China, find Treasury securities attractive 
because the market for U.S. government securities is one of the 
deepest and most liquid markets in the world and because the 
U.S. dollar is widely accepted as the premier reserve currency.

Q.61. Some observers see a new asset bubble forming in the 
stock market. Does it concern you that under some measures the 
current price to earnings ratio on the S&P 500 is considerably 
higher than the ratio when Alan Greenspan gave his ``irrational 
exuberance'' speech?

A.61. While assessing the fundamental values of financial 
assets is inherently very difficult, there is not much evidence 
to suggest that the stock market is currently in a bubble. 
Broad stock-price indexes have increased markedly since their 
troughs early this year. However, share prices have yet to 
retrace all their losses since September 2008, and are 
substantially below their peaks in 2007. Even more to the 
point, measures of risk premiums on broad stock-price indexes, 
despite having narrowed substantially relative to their record 
highs in late 2008, are still very wide by historical 
standards, suggesting that investors are not overly sanguine 
about the risks of investing in the stock market. Consistent 
with that view, implied volatilities on broad stock-price 
indexes have hovered at elevated levels in recent months, even 
as the economy has begun to recover. All that said, stock 
values ultimately depend on the evolution of company earnings, 
which in turn depend on the path of the economy. Because 
economic forecasts are inherently very uncertain, the 
appropriate valuations of stocks are also uncertain.

Q.62. According to the transcript of the June 24-25 FOMC 
meeting you said ``Ambiguity has its uses but mostly in 
noncooperative games like poker. Monetary policy is a 
cooperative game. The whole point is to get financial markets 
on our side and for them to do some of our work for us. In an 
environment of low inflation and low interest rates, we need to 
seek ever greater clarity of communication to the markets and 
to the public.'' If you still believe that, why are you 
concerned about opening more information about monetary policy 
to the public eye through an audit or other means of increasing 
transparency?

A.62. I believe that transparency is critical to the effective 
conduct of monetary policy. Indeed, over the past several 
years, the Federal Reserve has taken significant steps to 
enhance the clarity of its communications to the public and the 
Congress. In the autumn of 2007, the FOMC began publishing the 
economic projections of Committee participants four times per 
year rather than semiannually. In early 2009, the FOMC extended 
the horizon of these forecasts to include longer-run 
projections, which provide information about participants' 
estimates of the longer-run sustainable rates of economic 
growth and unemployment and about their assessments of the 
longer-run average inflation rate that best fulfills the 
Federal Reserve's dual mandate. Last June, the Federal Reserve 
began publishing a monthly report entitled ``Credit and 
Liquidity Programs and the Balance Sheet'' that presents 
detailed information about the Federal Reserve's programs to 
foster market liquidity and financial stability.
    Moreover, the Congress--through the Government 
Accountability Office--can and does audit all aspects of the 
Federal Reserve's operations except for deliberations on 
monetary policy and related issues. The Congress specifically 
exempted those deliberations to protect monetary policy from 
short-term political pressures. The repeal of this exemption 
could lead households, businesses, and investors to conclude 
that the Federal Reserve would not be in a position to combat 
inflation pressures as effectively as in the past. As a result, 
inflation expectations would likely move higher, boosting 
interest rates and raising the cost of credit for households 
and businesses.

Q.63. Did you or anyone else at the Fed realize the extent to 
which bailing out AIG would benefit European banks?

A.63. At the time the decisions were made to provide financial 
assistance to AIG and subsequently to restructure that 
assistance, we knew that the company was a very large, 
diversified financial services company that had extensive 
interconnections with the financial markets in this country and 
globally. As I indicated in my testimony earlier this year 
before the House Financial Services Committee, the range of 
parties that had potential exposure to AIG was sweeping: 
millions of policyholders of its insurance subsidiaries in the 
United States and elsewhere, State, and local governments, 
workers whose 401(k) plans had purchased insurance from AIG, 
banks and investment banks that had loans or lines of credit to 
the company, and money market funds and others that held AIG's 
outstanding commercial paper. Those with AIG exposure consisted 
of individuals and businesses, financial institutions and 
commercial enterprises, private and governmental entities, and 
domestic and foreign parties.

Q.64. Did the effect of a failure of AIG on European banks in 
any way contribute to the decision to rescue AIG? If so, why 
did you not request European governments provide financial 
assistance as well?

A.64. As noted in the answer to question 63, the decisions to 
provide financial assistance to AIG and subsequently to 
restructure that assistance were based on a wide range of 
factors, including the potential exposure of a broad spectrum 
of financial market participants to the company. During the 
recent financial markets crisis, the Federal Reserve has 
coordinated with foreign central banks and bank regulators in 
implementing measures to stabilize the banking system globally. 
Several European governments provided financial assistance to 
banks within their jurisdictions as part of these efforts.

Q.65. Why were the monoline insurers allowed to fail while AIG 
was rescued, when they had significant derivatives exposure 
just like AIG?

A.65. AIG's near-failure occurred at an extraordinary time. 
Global financial markets were under unprecedented strains. 
Major financial firms were under intense stress and three very 
large firms--Fannie Mae, Freddie Mac, and Lehman Brothers--had 
recently failed or been placed into conservatorship. The 
Federal Reserve and the Treasury judged that, given the severe 
market and economic stresses prevailing at that time, the 
failure of AIG would have posed an unacceptable risk for the 
global financial system and our economy. A disorderly failure 
on the part of AIG would have directly affected insurance 
policyholders in the United States and worldwide, State and 
local government entities that had lent to AIG, 401(k) plans 
that had purchased insurance from AIG, financial institutions 
with large exposures to AIG, and money market mutual funds and 
others that had invested in AIG's commercial paper. More 
broadly, AIG's failure would have further damaged already 
fragile market confidence and could have precipitated a broad-
based run on financial institutions around the world.
    In contrast to AIG, the monoline insurers came under 
substantial pressure in an earlier period when market and 
economic strains were much less pronounced, and the effects of 
the failure of monolines were judged as being less likely to 
have serious adverse effects on the financial system and the 
economy.

Q.66. In November 2009, the AIG bailout was revised to give the 
New York Fed ownership of several AIG subsidiaries in exchange 
for a reduced balance owed on loans by the New York Fed. What 
was the valuation used by the Fed for these subsidiaries, and 
how was that valuation determined? Did the Fed or AIG try to 
sell the subsidiaries to private entities? If so, what was the 
result, and if not, why not? What is the Fed's plan to dispose 
of the equity stakes?

A.66. The revolving credit facility is fully secured by all the 
unencumbered assets of AIG, including the shares of 
substantially all of AIG's subsidiaries. The loan was extended 
with the expectation that AIG would repay the credits with the 
proceeds from the sale of its operations and subsidiaries. The 
credit agreement stipulates that the net proceeds from all 
sales of subsidiaries of AIG must first be offered to pay down 
the credit extended by the Federal Reserve. AIG has developed a 
plan to divest its noncore business in order to repay U.S. 
government support.
    Most recently, AIG has begun the process of selling two of 
its insurance subsidiaries with significant business overseas, 
American International Assurance Co. (AIA) and American Life 
Insurance Company (ALICO). The step taken last week by the 
Federal Reserve to accept shares in two newly created companies 
that hold the common stock of AIA and ALICO, respectively, in 
satisfaction of a portion of the credit extended by the Federal 
Reserve facilitates the sale of these two companies and the 
repayment of the Federal Reserve. The value of the Federal 
Reserve's preferred interests represents a percentage of the 
market value of AIA and ALICO, based on valuations provided by 
independent advisers. AIA has announced plans for an initial 
public offering in 2010 and ALICO has announced that it has 
positioned itself for an initial public offering or a sale to a 
third party. AIG also continues to pursue the sale of other 
subsidiaries, the net proceeds of which would be applied to 
repay the AIG loan.

Q.67. Have you recommended any candidates to fill the empty 
seats on the Board of Governors? If so, who?

A.67. No. The selection of Board members of the Federal Reserve 
is the responsibility of the President of the United States. 
Every President takes this responsibility seriously and I am 
therefore confident he is committed to filling the vacant seats 
with well-qualified individuals.

Q.68. Andrew Haldane, head of financial stability at the Bank 
of England, argues that the relationship between the banking 
system and the government (in the U.K. and the U.S.) creates a 
``doom loop'' in which there are repeated boom-bust-bailout 
cycles that tend to get cost the taxpayer more and pose greater 
threat to the macroeconomy over time. What can be done to break 
this loop?

A.68. The ``doom loop'' that Andrew Haldane describes is a 
consequence of the problem of moral hazard in which the 
existence of explicit government backstops (such as deposit 
insurance or liquidity facilities) or of presumed government 
support leads firms to take on more risk or rely on less robust 
funding than they would otherwise. The new financial regulatory 
structure that I and others have proposed to counteract moral 
hazard would address this problem. In particular, a stronger 
financial regulatory structure would include: a consolidated 
supervisory framework for all financial institutions that may 
pose significant risk to the financial system; consideration in 
this framework of the risks that an entity may pose, either 
through its own actions or through interactions with other 
firms or markets, to the broader financial system; a systemic 
risk oversight council to identify, and coordinate responses 
to, emerging risks to financial stability; and a new special 
resolution process that would allow the government to wind down 
in an orderly way a failing systemically important nonbank 
financial institution (the disorderly failure of which would 
otherwise threaten the entire financial system), while also 
imposing losses on the firm's shareholders and creditors. The 
imposition of losses would reduce the costs to taxpayers should 
a failure occur.

Q.69. Mervyn King, governor of the Bank of England, argued in 
his recent Edinburgh speech that re-regulating the financial 
system will not effectively reduce its risks. And history 
suggests that Big Finance always gets ahead of even the most 
able regulators. Governor King insists instead that the largest 
banks should be broken up, so they are no longer ``too big to 
fail.'' Paul Volcker and Alan Greenspan, in recent statements, 
have supported the same broad approach. Can you explain why you 
differ from Mervyn King, Paul Volcker, and Alan Greenspan on 
this policy prescription?

A.69. I agree that no financial institution should be too big 
to fail. The policy of the Federal Reserve is that systemically 
important institutions should be regulated in a way that 
recognizes the full panoply of risks that they present to the 
financial system and to the economy more broadly. Such risks 
include but may not be limited to credit, liquidity, 
operational, and systemic risks. A difficulty of the prior 
regulatory framework is that sufficient charges and 
requirements were not imposed on such institutions, leaving 
them with an inappropriate incentive to become large and 
complex for the sake of possibly becoming recognized as too big 
to fail. The regulatory approach we are currently working to 
develop and implement seeks to correct this important 
shortcoming by imposing a comprehensive and robust set of 
safeguards, capital charges, and other measures that are 
designed to reflect the full range of risks posed by large, 
complex organizations. While significant challenges to 
developing and implementing such an approach exist, an 
appropriately calibrated system along these lines should help 
reduce the potential for any firm to be too big to fail. An 
important complement to stronger regulation and supervision, 
however, is the development of an effective resolution regime 
that would allow the government to wind down in an orderly way 
a troubled financial firm even in cases where a disorderly 
failure would pose a threat to the financial system and the 
economy.

Q.70. In the time between the bailout of Bear Stearns and the 
failure of Lehman, should you or the Treasury have more clearly 
communicated that firms should not expect government 
assistance? Why do you think Lehman, AIG, and others continued 
to act like there would be such assistance? Are there any 
lessons we should learn from that period that are applicable to 
efforts to reform our financial regulation?

A.70. Between the time of the near failure of Bear Stearns and 
the collapse of Lehman, a number of troubled financial 
institutions did in fact fail or were acquired by other 
financial institutions in private transactions. Moreover, in 
the aftermath of JPMorgan Chase's acquisition of Bear Stearns, 
many financial firms took steps to strengthen their financial 
positions, including writing down troubled assets, raising 
capital, and reducing leverage. However, these steps were not 
sufficient in many cases to allow the firms to survive the 
worsening of the financial crisis in the fall of 2008. Our 
decisions at that time, like those we took at each stage of the 
crisis, depended critically on the details of the circumstances 
then prevailing. As I have outlined elsewhere, a concerted 
effort was made to find a private-sector solution to the 
problems at Lehman. Had a viable buyer emerged, the Federal 
Reserve would have strongly supported the sale, but in the 
event, no such buyer was forthcoming. Moreover, providers of 
both secured and unsecured credit to the company were rapidly 
pulling away from the company and the company needed funding 
well above the amount that could be provided on a secured 
basis. Before the enactment of the legislation authorizing the 
TARP, the government lacked the ability to inject capital to 
prevent the disorderly collapse of a failing systemically 
important nonbanking institution. In light of these 
circumstances, failure was the only possible outcome for 
Lehman. Two critical lessons should be gleaned from the Lehman 
experience. First, Congress must ensure that all systemically 
important firms are subject to robust consolidated supervision. 
Second, going forward, there is an acute need for the Congress 
to enact a resolution regime that would allow the government to 
wind down a failing systemically important nonbank financial 
institution in an orderly way, and to impose losses as 
appropriate on shareholders and creditors.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
                      FROM BEN S. BERNANKE

Q.1. The current policy of the Federal Reserve is keeping 
interest rates near zero. This is allowing banks to earn a lot 
of money by buying long term government bonds and using that 
money to recapitalize the banks--which is a good thing--but, if 
the Federal Reserve continues this policy for an extended time, 
why would banks lend to consumers when even the least risky 
consumer is far riskier than buying U.S. Treasuries? Doesn't 
this Federal Reserve policy discourage the lending Washington 
policy makers say they're trying to promote?

A.1. In response to the sharp decline in economic activity late 
last year, the FOMC lowered its target for the Federal funds 
rate to a range of 0 to \1/4\ percent. This action, along with 
the Federal Reserve's other policy initiatives, was taken to 
foster the Federal Reserve's dual objectives of maximum 
employment and stable prices. As is usually the case, long-term 
interest rates did not decline by as much as short-term rates 
in response to the cuts in the funds rate. However, the 
relatively high interest rates on longer-term securities do not 
provide banks or other investors with an easy and low-risk 
source of profits, because investments in such securities 
involve a significant degree of interest rate risk; therefore, 
relatively high longer-term yields are unlikely to be an 
important reason for the current reluctance of banks to lend. 
Instead, that reluctance appears to be due more to the banks' 
concerns about the economic outlook, credit risks associated 
with that outlook, and to some extent, to the banks' own 
capital positions. The contraction in bank loans outstanding is 
also attributable in part to low demand for bank credit, which 
in turn is also largely a result of the economic downturn and 
concerns about the outlook. As part of our effort to support 
appropriate bank lending, the Federal Reserve and the other 
Federal banking agencies issued regulatory guidance in November 
2008 to encourage banks to meet the needs of their creditworthy 
customers. We have also encouraged banks to raise private 
capital to support more lending. In particular, the Federal 
Reserve led the Supervisory Capital Assessment Program (or 
``stress test'') of the largest bank holding companies last 
spring; the results of the stress test increased confidence in 
the banking system and helped many banks raise private capital 
and repay TARP funds. We have also eased lending conditions by 
providing banks with ample short-term funding and by helping to 
revive securitization markets. We expect that, as economic 
activity picks up, the demand for loans should increase, credit 
conditions are likely to ease, and banks will likely step up 
their crucial intermediation activities.

Q.2. In July, as part of your last appearance before this 
Committee, you were asked if you plan to hold the Treasury and 
GSE securities on your books until maturity. You responded, 
``the evolution of the economy, the financial system, and 
inflation pressures remain subject to considerable uncertainty. 
Reflecting this uncertainty, the way in which various monetary 
policy tools will be used in the future by the Federal Reserve 
has not yet been determined. In particular, the Federal Reserve 
has not developed specific plans for its holdings of Treasury 
and GSE securities.'' Basically, you had no plan to unwind this 
swollen portion of the Fed balance sheet. Do you have a plan 
yet, Mr. Chairman?

A.2. Broadly, our plan is to manage the System's portfolio of 
securities over time in a way that fosters the achievement of 
the Federal Reserve's statutory objectives of maximum 
employment and stable prices. As with other aspects of the 
conduct of monetary policy, the way in which the System's 
portfolio evolves will be determined by the emerging outlook 
for the economy, inflation, and financial markets. For example, 
it is possible that the Federal Reserve's holdings of Treasury 
and GSE securities will decline gradually, reflecting 
prepayments and maturing issues. In this case, the payment of 
interest on reserves along with reserve management tools may 
prove adequate for the implementation of appropriate policy 
adjustments. Depending on how economic and financial conditions 
evolve, however, the FOMC could determine that a more rapid 
reduction in the size of the portfolio would be desirable and 
so choose to sell some of the securities. That judgment would 
involve weighing many factors including the implications that 
such actions would have for long-term interest rates, including 
mortgage rates, and the related effects on economic growth, 
inflation, and financial markets.

Q.3. Over the last year, the Federal Reserve has introduced $1 
trillion into the banking system. The Federal Reserve continues 
to expand its purchases of mortgage backed securities. Chairman 
Bernanke, in past testimony before this Committee you have said 
that part of the plan to rein in this excess liquidity is to 
pay banks interest on reserves. What rate of interest will you 
have to pay in order to accomplish this and what will that do 
to the economy?

A.3. The Federal Reserve is well positioned to remove the 
current extraordinary degree of monetary policy accommodation 
at the appropriate time. The Federal Open Market Committee 
(FOMC) sets a target level of the Federal funds rate that it 
believes will best foster the Federal Reserve's statutory 
objectives of maximum employment and price stability in view of 
its outlook for economic activity and inflation. The current 
and expected future values of the Federal funds rate influence 
longer-term interest rates and other asset prices. And those 
changes in turn affect household and business spending 
decisions. Currently, the FOMC has expressed its target for the 
Federal funds rate as a range from 0 to \1/4\ percent. The 
interest rate paid on reserves helps to keep the Federal funds 
rate close to the target set by the FOMC because banks will not 
ordinarily lend to one another in the Federal funds market at 
rates below what they can earn on balances maintained at the 
Federal Reserve. The interest rate paid on bank reserves will 
be set over time at a level that is consistent with, and in 
practice very close to, the FOMC's target Federal funds rate. 
As required by law, the interest rate paid on reserves must not 
exceed the general level of short-term interest rates.

Q.4. On Monday, the Dubai government said that it would not 
guarantee the debts of state-owned Dubai World. A senior 
finance official said, ``Creditors need to take part of the 
responsibility for their decision to lend to the companies. 
They think Dubai World is part of the government, which is not 
correct.'' Dubai world has since offered to restructure $26 
billion in debts. As a result, no great crisis has erupted in 
the markets. What lesson have you drawn from this?

A.4. The announcement by Dubai World that it would seek to 
restructure a portion of its debt payments caught many 
investors by surprise. Because the company is wholly owned by 
the government of Dubai, some investors had believed that the 
government would back its debt. While this news initially had 
some negative impact on global financial markets, those markets 
have recovered as market participants came to perceive that the 
losses associated with the restructuring likely would be 
contained. However, Dubai World's announcement has seriously 
affected the terms and availability of credit for the 
government and corporations in Dubai: Interest rates on debt 
issued by both the government and government-affiliated 
corporations have increased sharply, credit ratings of many of 
those corporations have been downgraded, and their ability to 
raise new funds has been seriously impaired. These developments 
reinforce the lesson that lenders will charge steep premiums if 
they have concerns that borrowers will fail to fully repay 
their investments.

Q.5. Tuesday, a New York Times report highlighted the fact that 
on December 14, 2008, well after receiving an injection of TARP 
money from the taxpayer, Citi announced $8 billion of financing 
for public sector entities in Dubai. Chairman Bernanke, did you 
know that Citi made this investment with the help of taxpayer 
funds? What scrutiny did the Federal Reserve give this 
transaction given the fact that Citi was forced to take tens of 
billions of dollars of TARP funds?

A.5. With the exception of mergers and acquisitions, the 
Federal Reserve does not pre-approve individual transactions of 
the financial institutions we supervise. We also note that cash 
in an institution is fungible, so it would not be accurate to 
state that TARP funds were used for this or any other 
individual investment. In many large deals like this one, the 
lead bank arranges the deal and then syndicates it to other 
investors, oftentimes removing a large share of the risk from 
its balance sheet.

Q.6. More than a year after the Federal Reserve bailed out the 
failing insurance giant; taxpayers deserve to know what the 
exit strategy is. Just this week the Federal Reserve Bank of 
New York bought two life insurance companies from AIG in 
exchange for reducing the debt the company owes the Fed by $25 
billion. It seems like a positive step, but owning two life 
insurance companies is hardly an exit from the morass of AIG. 
Will taxpayers get their money back from AIG and how much can 
they reasonably expect to get back?

A.6. The revolving credit facility is fully secured by all the 
unencumbered assets of AIG, including the shares of 
substantially all of AIG's subsidiaries. The loans were 
extended with the expectation that AIG would repay the credits 
with the proceeds from the sale of its operations and 
subsidiaries. The credit agreement stipulates that the net 
proceeds from all sales of subsidiaries of AIG must first be 
offered to pay down the credit extended by the Federal Reserve.
    Most recently, AIG has begun the process of selling two of 
its insurance subsidiaries with significant business overseas, 
American International Assurance Co. (AIA) and American Life 
Insurance Company (ALICO). The step taken last week by the 
Federal Reserve to accept shares in two newly created companies 
that hold the common stock of AIA and ALICO, respectively, in 
satisfaction of a portion of the credit extended by the Federal 
Reserve facilitates the sale of these two companies and the 
repayment of the Federal Reserve. The value of the Federal 
Reserve's preferred interests represents a percentage of the 
market value of AIA and ALICO, based on valuations provided by 
independent advisers. AIA has announced plans for an initial 
public offering in 2010 and ALICO has announced that it has 
positioned itself for an initial public offering or a sale to a 
third party. AIG also continues to pursue the sale of other 
subsidiaries, the net proceeds of which would be applied to 
repay the AIG loan.
    The loans made to Maiden Lane II LLC (ML II) and Maiden 
Lane III LLC (ML III), which are two special purpose vehicles 
formed to help stabilize AIG, will be repaid with the proceeds 
from the liquidation and disposition of the portfolio holdings 
of these two entities. If the portfolio holdings were 
liquidated today, based on fair value, the Federal Reserve 
would recover fully on its loan to ML III and incur a modest 
loss on its loan to ML II. However, the loans to ML II and ML 
III are not structured or designed for the immediate sale of 
collateral assets. Instead, the loans are designed to allow the 
sale of the collateral over a longer period that allows for the 
recovery of markets and the intrinsic asset values. In 
addition, AIG has a $1 billion subordinated position in ML II 
and a $5 billion subordinated position in ML III. These 
subordinated positions are available to absorb first any loss 
that ultimately is incurred by ML II or ML III, respectively. 
On this basis, the Board does not anticipate that the loans to 
ML II or ML III will result in the realization of any losses to 
the Federal Reserve or the taxpayers.
    Each of these matters is described more fully in the 
monthly reports filed with Congress by the Federal Reserve 
under section 129 of the Emergency Economic Stabilization Act 
of 2008, and can be found on the Board's Web site.

Q.7. Mr. Chairman, as I'm sure you know by now, the recent 
report issued by the Special Inspector General of the Troubled 
Asset Relief Program on payments made to AIG counterparties 
says that ``the Federal Reserve Bank New York's negotiating 
strategy to pursue concessions from counterparties offered 
little opportunity for success, even in light of the 
willingness of one counterparty to agree to concessions.'' How 
involved were you in the decision made by the Federal Reserve 
Board of New York to pay these counterparties at par?

A.7. I participated in and supported the Board's action to 
authorize lending to Maiden Lane III for the purpose of 
purchasing the CDOs in order to remove an enormous obstacle to 
AIG's future financial stability. I was not directly involved 
in the negotiations with the counterparties. These negotiations 
were handled primarily by the staff of Federal Reserve Bank of 
New York (FRBNY) on behalf of the Federal Reserve.
    With respect to the general issue of negotiating 
concessions, the FRBNY attempted to secure concessions but, for 
a variety of reasons, was unsuccessful. One critical factor 
that worked against successfully obtaining concessions was the 
counterparties' realization that the U.S. Government had 
determined that AIG was systemically important and would 
prevent a disorderly failure. In those circumstances, the 
government and the company had little or no leverage to extract 
concessions from any counterparties, including the 
counterparties on multi-sector CDOs, on their claims. 
Furthermore, it would not have been appropriate for the Federal 
Reserve to use its supervisory authority on behalf of AIG (an 
option the report raises) to obtain concessions from some 
domestic counterparties in purely commercial transactions in 
which some of the foreign counterparties would not grant, or 
were legally barred from granting, concessions. To do so would 
have been a misuse of the Federal Reserve's supervisory 
authority to further a private purpose in a commercial 
transaction and would have provided an advantage to foreign 
counterparties over domestic counterparties. We believe the 
Federal Reserve acted appropriately in conducting the 
negotiations, and that the negotiating strategy, including the 
decision to treat all counterparties equally, was not flawed or 
unreasonably limited.
    It is important to note that Maiden Lane III acquired the 
CDOs at market price at the time of the transaction. Under the 
contracts, the issuer of the CDO is obligated to pay Maiden 
Lane III at par, which is an amount in excess of the purchase 
price. Based on valuations from our advisors, we continue to 
believe the Federal Reserve's loan to Maiden Lane III will be 
fully repaid.
    The episode starkly illustrates the need for a special 
resolution regime for failing, systemically critical companies 
that will allow the government to protect the financial system 
while still being able to obtain concessions from shareholders, 
creditors, counterparties, and management. As I said at my 
hearing: ``We do not want any more AIGs. We do not want any 
more Lehman Brothers. We want a well established, well stated, 
identified, worked out system that can be used to wind down 
these companies, allow them to fail, let the creditors take 
losses, let counterparties, like the AIG counterparties, take 
losses, but without completely destabilizing the whole economy, 
as can happen.''

Q.8. In your last appearance before this Committee, Mr. 
Chairman, you and I talked about the proposal for GAO audits of 
the Federal Reserve. As you know, I support full, delayed 
audits of the Federal Reserve. The argument you and others make 
in opposition to these audits is that they would compromise the 
ability of the Federal Reserve to make monetary policy 
independently. Yet, you now support audits of emergency, 13(3) 
facilities even though you said that, ``because supporting 
economic growth when the economy has been adversely affected by 
various types of shocks is a key function of monetary policy, 
all of the facilities that are available to multiple 
institutions can be considered part of the Federal Reserve's 
monetary policy response to the crisis.'' How is it that you 
feel that some GAO audits of monetary policy are ok and others 
are not?

A.8. We have indicated our willingness to work with the 
Congress to enhance the review of the operational integrity of 
the temporary market credit facilities that we established 
under section 13(3) in a way that would not endanger our 
ability to independently determine and implement monetary 
policy. A review of the operational integrity of these 
facilities could be structured so as not to involve a review of 
the monetary policy aspects of the facility, such as the 
decision to begin or end the facility or the choices made 
regarding the structure, scope, design, or terms of the 
facility. The GAO already has the authority to conduct reviews 
of Federal Reserve lending under section 13(3) to single and 
specific entities, such as Bear Stearns, AIG, Citigroup and 
Bank of America Corporation, and we have been working with GAO 
to facilitate their audit of these facilities.
    We continue to be very concerned, however, about the 
proposals that would broadly authorize GAO to audit the Federal 
Reserve's monetary policy and discount window decision making 
and implementation. As you know, the Federal Reserve is already 
fully subject to audit by the GAO in virtually all of its other 
areas of responsibilities. The limited exceptions for monetary 
policy and discount window operations were adopted to ensure 
that the Federal Reserve could, in the words of the Senate 
committee report at the time, ``independently conduct the 
Nation's monetary policy.''
    Monetary policy independence enables policymakers to look 
beyond the short term as they weigh the effects of their 
monetary policy actions on price stability and employment and 
reinforces public confidence that monetary policy will be 
guided solely by the objectives laid out in the Federal Reserve 
Act and not by political concerns. Financial markets likely 
would see a GAO audit or the threat of a GAO audit of monetary 
policy as an attempt by Congress to intrude on the Federal 
Reserve's monetary policy judgments and to try to influence 
subsequent monetary policy decisions. Households, businesses, 
and financial market participants would understandably be 
uncertain about the implications of the GAO's findings for 
future decisions of the FOMC, thereby increasing market 
volatility and weakening the ability of monetary policy actions 
to achieve their desired effects. Actions that are viewed as 
weakening monetary policy independence likely would increase 
inflation fears and market interest rates and, ultimately, 
damage economic stability and job creation. Thus, maintaining 
an independent monetary policy is important not because it 
benefits the Federal Reserve, but because of the important 
public advantages it provides households, families, small and 
large businesses and the Nation as a whole.
    The Federal Reserve is highly transparent and is committed 
to providing Congress and the public with the information it 
needs to oversee the activities and decisions of the Federal 
Reserve without undermining our ability to effectively fulfill 
our monetary policy and other responsibilities. For example, 
the Federal Reserve is already subject to a full audit of its 
financial statements by an independent public accounting firm. 
These audited financial statements are published annually and 
reported to Congress. In addition, the Federal Reserve 
publishes a detailed balance sheet on a weekly basis--unique 
among central banks--showing all of its assets and liabilities 
as well as changes in entries on its financial statements from 
the previous week. This allows Congress and the public full 
access to information on the assets and liabilities incurred by 
the Federal Reserve on a regular and consistent basis. We also 
make substantial, detailed information available on our Web 
site and in regular public reports regarding the programs, 
credit facilities and monetary policy decisions of the Federal 
Reserve.

Q.9. Mr. Chairman, in the House Financial Services Committee's 
consideration of the systemic regulation bill, it narrowly 
adopted an amendment that requires a 20 percent haircut for all 
secured creditors in the case of an institution identified as 
systemically important. The sponsors stated that the intent was 
to prevent secured lenders from requiring additional collateral 
as the institution failed. Also the FDIC, who supports, the 
amendment argues it would incentivize secured lenders to review 
secured borrowers more closely. It appears to me that the 
proposal would significantly increase cost of secured borrowing 
and be potentially disruptive of a number of secured lending 
markets such as the repurchase agreements, advances from the 
Federal Home Loan Banks, and possibly some of the Fed's own 
activities. Also, it is my understanding that secured creditors 
spend significant resources today assessing the 
creditworthiness of the borrowers as well as the value of the 
pledged collateral. Have you had a chance to review the 
proposal and form an opinion on the impact it has on the 
institutions and the market?

A.9. Based on an initial review of the proposal, the Federal 
Reserve has concerns regarding the destabilizing effect the 
proposal could have on financial markets and institutions. If 
implemented, the proposal could make liquidity crises more 
frequent, more rapid, and more severe. It could create 
incentives for secured creditors of a systemically important 
institution to ``rush to the exits'' at early signs of 
financial difficulties, shutting the institution off from 
useful sources of liquidity and perhaps turning temporary 
financial problems into terminal ones. Moreover, introducing 
change into the secured financing markets should be done with 
great care and consideration of potential ramifications. The 
Federal Reserve relies upon deep and liquid secured financing 
markets in its implementation of monetary policy. Policymakers 
should carefully evaluate the implications of any proposal to 
change established market practices on market functioning and 
potentially on the conduct of monetary policy.

Q.10. Can you cite an example of when in its history the 
Federal Reserve was early about doing something on a looming 
banking crisis?

A.10. In the period leading up to the crisis, the Federal 
Reserve and other U.S. banking supervisors took several 
important steps to improve the safety and soundness of banking 
organizations and the resilience of the financial system. For 
example, following the September 11, 2001, terrorist attacks, 
we took steps to improve clearing and settlement processes, 
business continuity for critical financial market activities, 
and compliance with Bank Secrecy Act, anti-money laundering, 
and sanctions requirements. Other areas of focus pertained to 
credit card subprime lending, the growth in leveraged lending, 
credit risk management practices for home equity lending, 
counterparty credit risk related to hedge funds, and effective 
accounting controls after the fall of Enron. These are examples 
in which the Federal Reserve took aggressive action with a 
number of financial institutions, demonstrating that effective 
supervision can bring about material improvements in risk 
management and compliance practices at supervised institutions.
    In addition, the Federal Reserve, working with the other 
U.S. banking agencies, issued several pieces of supervisory 
guidance before the onset of the recent crisis--taking action 
on nontraditional mortgages, commercial real estate, home 
equity lending, complex structured financial transactions, and 
subprime lending--to highlight emerging risks and point bankers 
to prudential risk management practices they should follow. 
Moreover, we identified a number of potential issues and 
concerns and communicated those concerns to the industry 
through the guidance and through our supervisory activities.

Q.11. Chairman Bernanke, what share of the blame does the 
Federal Reserve bear for the catastrophe of last year?

A.11. As I stated in a speech on October 23, entitled, 
``Financial Regulation and Supervision after the Crisis: The 
Role of the Federal Reserve,'' this crisis was an 
extraordinarily complex event with multiple causes. Weaknesses 
in the risk-management practices of many financial firms, 
together with insufficient buffers on capital and liquidity, 
were clearly an important factor in the crisis. Unfortunately, 
regulators and supervisors did not identify and remedy many of 
those weaknesses in a timely way. All financial regulators, 
including of course the Federal Reserve, must take a hard look 
at the experience of the past 2 years, correct identified 
shortcomings, and improve future performance. Over the past 
several months, the Federal Reserve has taken several 
significant steps to strengthen its regulatory and supervisory 
framework.

Q.12. Chairman Bernanke, what was the biggest mistake you made 
over the last year?

A.12. It is an extraordinary privilege to work at the Federal 
Reserve. I work with some of the most talented individuals one 
would find in either the private or public sector. Although I 
try to take every opportunity to thank my colleagues, given the 
extraordinary challenges they have confronted the past few 
years, I am sure I could have said it more often.
    As I testified before the Committee, a financial crisis of 
the severity we have experienced must prompt financial 
institutions and regulators alike to undertake unsparing self-
assessments of their past performance. Clearly, financial 
regulators, including the Federal Reserve, did not do enough to 
prevent excessive risk-taking in our financial system. At the 
Federal Reserve, we have been actively engaged in identifying 
and implementing improvements in our regulation and supervision 
of financial firms. In the realm of consumer protection, during 
the past 3 years, we have comprehensively overhauled 
regulations aimed at ensuring fair treatment of mortgage 
borrowers and credit card users, among numerous other 
initiatives. To promote safety and soundness, we continue to 
work with other domestic and foreign supervisors to require 
stronger capital, liquidity, and risk management at banking 
organizations, while also taking steps to ensure that 
compensation packages do not provide incentives for excessive 
risk-taking and an undue focus on short-term results. Drawing 
on our experience in leading the recent comprehensive 
assessment of 19 of the largest U.S. banks, we are expanding 
and improving our cross-firm, or horizontal, reviews of large 
institutions, which will afford us greater insight into 
industry practices and possible emerging risks. To complement 
on-site supervisory reviews, we are also creating an enhanced 
quantitative surveillance program that will make use of the 
skills not only of supervisors, but also of economists, 
specialists in financial markets, and other experts within the 
Federal Reserve. We are requiring large firms to provide 
supervisors with more detailed and timely information on risk 
positions, operating performance, and other key indicators, and 
we are strengthening consolidated supervision to better capture 
the firmwide risks faced by complex organizations. In sum, 
heeding the lessons of the crisis, we are committed to taking a 
more proactive and comprehensive approach to oversight to 
ensure that emerging problems are identified early and met with 
prompt and effective supervisory responses.

Q.13. Given the benefit of hindsight, would you still bail out 
Bear Stearns in the way that you did last year? What would you 
do differently?

A.13. At the time of the near collapse of the investment bank 
Bear Stearns, Federal Reserve lending under section 13(3) of 
the Federal Reserve Act was the only tool available to the U.S. 
Government to prevent the disorderly collapse of the company. A 
disorderly failure of Bear Stearns in early 2008 could have had 
seriously adverse effects on financial markets and financial 
institutions, effects that--as later demonstrated in the case 
of Lehman Brothers--could have been extremely difficult to 
contain. The adverse effects would not have been confined to 
the financial system but would have been felt broadly in the 
real economy through their effects on asset values and credit 
availability. In light of these facts, I believe the Federal 
Reserve, with the full support of the Treasury Department, 
acted appropriately in providing secured loans to facilitate 
the acquisition of Bear Stearns by JPMorgan Chase.
    The events associated with Bear Stearns clearly highlight 
the need for strong, consolidated supervision of all 
systemically important firms--not just those that own a bank. 
They also demonstrate the need for a resolution regime that 
would allow the orderly wind down or restructuring of a 
financial firm the disorderly failure of which would otherwise 
threaten financial stability and the economy.

Q.14. On November 24, 2009, Reuters reported that the U.S. 
Federal Reserve asked banks that were part of its so-called 
``stress tests'' to submit plans to repay government money lent 
to them under the Trouble Asset Relief Program (TARP).
    Without going into specifics on individual financial 
institutions or naming names, do you foresee any financial 
institutions that will have trouble repaying their TARP money? 
How will you handle companies that face challenges in repaying 
taxpayer money?

A.14. With respect to the firms that participated in the 
``stress test,'' 18 of the 19 had TARP preferred stock. Of 
those 18 firms, 10 have now fully redeemed their TARP capital. 
Each of those firms issued significant common equity in 
connection with the TARP redemption. The Federal Reserve and 
other supervisors are in discussions with the remaining 8 SCAP 
firms that have outstanding TARP capital in order to facilitate 
reduced reliance on TARP capital, while ensuring they can 
maintain capital levels consistent with supervisory 
expectations after any proposed redemption.
    Among the many companies that received TARP Capital 
Purchase Program investments, which include firms not subject 
to SCAP, it is likely that some will have trouble repaying 
their TARP funds. Indeed, some institutions that received TARP 
investments have since reported significant financial 
deterioration and have already deferred payment of interest/
dividends on their TARP securities in order to preserve 
capital. The banking agencies will address companies that face 
challenges in repaying TARP investments in the same manner that 
they address other companies facing capital constraints. To the 
extent that the repayment of TARP instruments or payment of 
dividends on the TARP funds would raise questions about the 
adequacy of capital at an insured depository or its 
consolidated parent company, the banking agencies may object to 
the payout and require the institution to retain the investment 
in order to preserve its resources and meet obligations to 
insured depositors.

Q.15. On December 3, 2009, The Wall Street Journal reported 
that the Bank of America is set to repay its TARP funds. Given 
that news, along with the Federal Reserve's request that 
financial institutions submit plans for repayment and the 
critical role that you played lobbying Congress for the 
creation of TARP I am interested in your opinion on the need to 
continue the program. As you know the authority to purchase new 
troubled assets under TARP expires on December 31, 2009, but 
that it can be extended for almost another year. Do you believe 
that the stability of our Nation's financial system 
necessitates an extension of this bailout program?

A.15. The TARP program has contributed significantly to the 
improved conditions in financial markets. By providing capital 
to be invested in numerous financial institutions and 
establishing programs to restore the flow of credit, TARP has 
been a key stabilizing factor for the financial system. But 
more progress is needed. Far too many Americans are without 
jobs, and unemployment could remain high for some time even if, 
as we anticipate, moderate economic growth continues. Small 
businesses continue to face challenging credit conditions 
although, as I noted in my testimony before the Banking 
Committee, the Term Asset-Backed Securities Loan Facility has 
made an important contribution by helping to finance some 
480,000 loans to small businesses. More broadly, the financial 
system has not yet fully recovered and remains vulnerable to 
unexpected shocks in the near future. Indeed many of the 
favorable indications in financial markets remain linked to the 
presence of TARP and other government initiatives, including 
the extraordinary actions taken by the Federal Reserve under 
its monetary policy and financial stability authorities that I 
outlined in my testimony. In his recent letter to the Congress 
about the extension of the TARP, Secretary Geithner struck a 
reasonable balance in stating his intention to dedicate most of 
the remaining TARP funds to deficit reduction while maintaining 
for a period the capacity to respond should financial 
conditions unexpectedly worsen.

Q.16.a. The Wall Street Journal reported on some questions that 
different economists felt that you should answer. Let me borrow 
from some of those and I will credit them with their questions 
accordingly:
    Anil Kashyap, University of Chicago Booth Graduate School 
of Business: With the unemployment rate hovering around 10 
percent, the public seems outraged at the combination of three 
things: (a) substantial TARP support to keep some firms alive, 
(b) allowing these firms to pay back the TARP money quickly, 
(c) no constraints on pay or other behavior once the money was 
repaid. Was it a mistake to allow (b) and/or (c)?

A.16.a. TARP capital purchase program investments were always 
intended to be limited in duration. Indeed, the step-up in the 
dividend rate over time and the reduction in TARP warrants 
following certain private equity raises were designed to 
encourage TARP recipients to replace TARP funds with private 
equity as soon as practical. As market conditions have 
improved, some institutions have been able to access new 
sources of capital sooner than was originally anticipated and 
have demonstrated through stress testing that they possess 
resources sufficient to maintain sound capital positions over 
future quarters. In light of their ability to raise private 
capital and meet other supervisory expectations, some companies 
have been allowed to repay or replace their TARP obligations. 
No targeted constraints have been placed on companies that have 
repaid TARP investments. However, these companies remain 
subject to the full range of supervisory requirements and 
rules. The Federal Reserve has taken steps to address 
compensation practices across all firms that we supervise, not 
just TARP recipients. Moreover, in response to the recent 
crisis, supervisors have undertaken a comprehensive review of 
prudential standards that will likely result in more stringent 
requirements for capital, liquidity, and risk management for 
all financial institutions, including those that participated 
in the TARP programs.

Q.16.b. Mark Thoma, University of Oregon and blogger: What is 
the single, most important cause of the crisis and what is 
being done to prevent its reoccurrence? The proposed regulatory 
structure seems to take as given that large, potentially 
systemically important firms will exist, hence, the call for 
ready, on the shelf plans for the dissolution of such firms and 
for the authority to dissolve them. Why are large firms 
necessary? Would breaking them up reduce risk?

A.16.b. The principal cause of the financial crisis and 
economic slowdown was the collapse of the global credit boom 
and the ensuing problems at financial institutions, triggered 
by the end of the housing expansion in the United States and 
other countries. Financial institutions have been adversely 
affected by the financial crisis itself, as well as by the 
ensuing economic downturn.
    This crisis did not begin with depositor runs on banks, but 
with investor runs on firms that financed their holdings of 
securities in the wholesale money markets. Much of this 
occurred outside of the supervisory framework currently 
established. An effective agenda for containing systemic risk 
thus requires elimination of gaps in the regulatory structure, 
a focus on macroprudential risks, and adjustments by all our 
financial regulatory agencies.
    Supervisors in the United States and abroad are now 
actively reviewing prudential standards and supervisory 
approaches to incorporate the lessons of the crisis. For our 
part, the Federal Reserve is participating in a range of joint 
efforts to ensure that large, systemically critical financial 
institutions hold more and higher-quality capital, improve 
their risk-management practices, have more robust liquidity 
management, employ compensation structures that provide 
appropriate performance and risk-taking incentives, and deal 
fairly with consumers. On the supervisory front, we are taking 
steps to strengthen oversight and enforcement, particularly at 
the firm-wide level, and we are augmenting our traditional 
microprudential, or firm-specific, methods of oversight with a 
more macroprudential, or system-wide, approach that should help 
us better anticipate and mitigate broader threats to financial 
stability.
    Although regulators can do a great deal on their own to 
improve financial regulation and oversight, the Congress also 
must act to address the extremely serious problem posed by 
firms perceived as ``too big to fail.'' Legislative action is 
needed to create new mechanisms for oversight of the financial 
system as a whole. Two important elements would be to subject 
all systemically important financial firms to effective 
consolidated supervision and to establish procedures for 
winding down a failing, systemically critical institution to 
avoid seriously damaging the financial system and the economy.
    Some observers have suggested that existing large firms 
should be split up into smaller, not-too-big-to-fail entities 
in order to reduce risk. While this idea may be worth 
considering, policymakers should also consider that size may, 
in some cases, confer genuine economic benefits. For example, 
large firms may be better able to meet the needs of global 
customers. Moreover, size alone is not a sufficient indicator 
of systemic risk and, as history shows, smaller firms can also 
be involved in systemic crises. Two other important indicators 
of systemic risk, aside from size, are the degree to which a 
firm is interconnected with other financial firms and markets, 
and the degree to which a firm provides critical financial 
services. An alternative to limiting size in order to reduce 
risk would be to implement a more effective system of 
macroprudential regulation. One hallmark of such a system would 
be comprehensive and vigorous consolidated supervision of all 
systemically important financial firms. Under such a system, 
supervisors could, for example, prohibit firms from engaging in 
certain activities when those firms lack the managerial 
capacity and risk controls to engage in such activities safely. 
Congress has an important role to play in the creation of a 
more robust system of financial regulation, by establishing a 
process that would allow a failing, systemically important 
nonbank financial institution to be wound down in an orderly 
fashion, without jeopardizing financial stability. Such a 
resolution process would be the logical complement to the 
process already available to the FDIC for the resolution of 
banks.

Q.16.c. Simon Johnson, Massachusetts Institute of Technology 
and blogger: Andrew Haldane, head of financial stability at the 
Bank of England, argues that the relationship between the 
banking system and the government (in the U.K. and the U.S.) 
creates a ``doom loop'' in which there are repeated boom-bust-
bailout cycles that tend to get cost the taxpayer more and pose 
greater threat to the macro economy over time. What can be done 
to break this loop?

A.16.c. The ``doom loop'' that Andrew Haldane describes is a 
consequence of the problem of moral hazard in which the 
existence of explicit government backstops (such as deposit 
insurance or liquidity facilities) or of presumed government 
support leads firms to take on more risk or rely on less robust 
funding than they would otherwise. A new regulatory structure 
should address this problem. In particular, a stronger 
financial regulatory structure would include: a consolidated 
supervisory framework for all financial institutions that may 
pose significant risk to the financial system; consideration in 
this framework of the risks that an entity may pose, either 
through its own actions or through interactions with other 
firms or markets, to the broader financial system; a systemic 
risk oversight council to identify, and coordinate responses 
to, emerging risks to financial stability; and a new special 
resolution process that would allow the government to wind down 
in an orderly way a failing systemically important nonbank 
financial institution (the disorderly failure of which would 
otherwise threaten the entire financial system), while also 
imposing losses on the firm's shareholders and creditors. The 
imposition of losses would reduce the costs to taxpayers should 
a failure occur.

Q.16.d. Brad Delong, University of California at Berkeley and 
blogger: Why haven't you adopted a 3 percent per year inflation 
target?

A.16.d. The public's understanding of the Federal Reserve's 
commitment to price stability helps to anchor inflation 
expectations and enhances the effectiveness of monetary policy, 
thereby contributing to stability in both prices and economic 
activity. Indeed, the longer-run inflation expectations of 
households and businesses have remained very stable over recent 
years. The Federal Reserve has not followed the suggestion of 
some that it pursue a monetary policy strategy aimed at pushing 
up longer-run inflation expectations. In theory, such an 
approach could reduce real interest rates and so stimulate 
spending and output. However, that theoretical argument ignores 
the risk that such a policy could cause the public to lose 
confidence in the central bank's willingness to resist further 
upward shifts in inflation, and so undermine the effectiveness 
of monetary policy going forward. The anchoring of inflation 
expectations is a hard-won success that has been achieved over 
the course of three decades, and this stability cannot be taken 
for granted. Therefore, the Federal Reserve's policy actions as 
well as its communications have been aimed at keeping inflation 
expectations firmly anchored.

Q.17. The Obama administration uses a phrase that, before the 
beginning of the year, I was not all that familiar with. They 
talk about jobs that are ``created or saved.'' As an economist, 
can you define what a ``saved'' job is? How would one measure 
how many jobs are being saved? Do you know of any economist or 
Federal agency that measures the number of jobs saved (if they 
do, please provide some detail as to when they decided to track 
that number and how they define it and measure it)?

A.17. The Council of Economic Advisers has been compiling the 
Administration's estimates of jobs created or saved, and can 
provide you with the details of their methodology. In general, 
the challenge in estimating jobs created or saved is the need 
to try to estimate how employment would have evolved in the 
absence of the policy being considered.

Q.18. Section 109 of the recently enacted ``Credit Card 
Accountability, Responsibility and Disclosure Act of 2009'' 
(P.L. 111-24) requires card issuers to consider the ability of 
a consumer to make required payments on an account before 
opening the account or increasing an existing line of credit. 
The provision in Section 109 results from an amendment that was 
proposed to the underlying legislation. The original amendment 
would have required card issuers to consider income and similar 
metrics when evaluating an applicant's or cardholder's ability 
to make payments on a credit card account. Such specificity was 
deleted in the amendment that was ultimately adopted as part of 
the Credit CARD Act. Furthermore, again unlike in the mortgage 
context, obtaining income and asset information can be very 
difficult in the context of a credit card relationship, 
especially in connection with credit line increases and credit 
obtained at the point of sale.
    Could you explain why the Board's proposed regulations to 
implement Section 109 reinserted the notion that card issuers 
must consider income or assets despite what appeared to be 
clear indications that Congress did not believe it was 
necessary?
    Can you please provide the Committee any and all 
information the Board considered when it determined that the 
consideration of income/assets would result in a statistically 
significant improvement in the underwriting of credit card 
loans? If you do not have any such information, or if the Board 
cannot conclude that the consideration of income/assets results 
in a statistically significant underwriting improvement, please 
indicate such.
    Please quantify for the Committee the benefits associated 
with the consideration of a consumer's income or assets in 
connection with a credit card loan and compare them to the 
operational and other costs associated with such a requirement. 
Please include, in particular, costs such as systems changes, 
reduced credit availability at the point of sale, the adverse 
selection of relying on consumers to request credit line 
increases, and consumer dissatisfaction that would result.
    Assume a credit card issuer obtains income information from 
an applicant, and obtains information from a consumer report 
about the consumer's credit obligations. Would you please 
provide examples of what a card issuer should do with this 
information, and statistical (or other) evidence of how such 
information would demonstrably improve upon other underwriting 
mechanisms?

A.18. Our implementation of the Credit Card Accountability, 
Responsibility and Disclosure Act of 2009 (``Card Act'') has 
followed the process used by the Board in other rulemakings. 
After reviewing the statutory language and legislative history 
of the Act, including Section 109, we conducted outreach 
meetings with both industry representatives (including 
retailers) and consumer groups to inform our judgments about 
the best way to implement the statute. We also drew on our 
recent experience in developing mortgage regulations that 
require creditors to consider consumers' ability to make the 
scheduled loan payments.
    Section 109 requires card issuers to consider a consumer's 
ability to make the required payments under the terms of the 
account before opening the account or increasing an existing 
credit limit. Under the Board's proposal, a card issuer must, 
at a minimum, consider the consumer's ability to make the 
required minimum periodic payments after reviewing the 
consumer's income or assets as well as the consumer's current 
obligations. The proposed rules specify, however, that card 
issuers may also consider other factors traditionally used by 
the industry in determining creditworthiness, such as the 
consumer's payment history, credit report, or credit score. 
These additional factors provide creditors with useful 
information about a consumer's past propensity to pay.
    The Board's publication of the proposed rules did not 
reflect a final determination regarding the appropriate method 
for ensuring that a card issuer considers a consumer's ability 
to make the required payments. Instead, the Board provided the 
public with an opportunity to comment on the advantages and 
disadvantages of the proposed rules. The comments we received 
raised many of the same issues you have raised. In particular, 
comments from card issuers and retailers generally stated that 
there are significant operational and other costs associated 
with collecting and considering information about a consumer's 
income or assets. However, comments from consumer groups 
supported consideration of income or asset information and 
urged the Board to go further by requiring that this 
information be verified through documentation or other means. 
The Board is currently in the process of considering these and 
other issues raised by the public comments in order to develop 
a final rule.

Q.19. At your hearing you said that the Federal Reserve did not 
see any asset bubbles in the U.S. Why don't you consider what 
is occurring in the gold market to be a bubble? Or, should we 
see it as a forward indicator of increasing inflation?

A.19. Gold is used for a wide range of purposes, including as 
an investment, a reserve asset, or in the production of jewelry 
and other products. Accordingly, it is often unclear whether 
movements in gold prices owe to changes in supply or demand, 
and whether those movements are consistent with fundamentals or 
might indicate a bubble. However, the recent rise in gold 
prices has not been much out of line with the increases in 
other commodities, suggesting that increases in gold prices 
might well be consistent with fundamentals, perhaps reflecting 
the global economic recovery. Gold prices may also reflect 
general economic uncertainty. As measures of U.S. expected 
inflation drawn from inflation-protected bond yields and from 
surveys of consumers and professional forecasters have remained 
well contained, it seems unlikely that higher gold prices 
signal higher inflation expectations.

Q.20. Are you concerned that Congress with various fiscal 
policies and the Federal Reserve with its various monetary 
policies, low Federal funds rate and purchasing mortgage backed 
securities and Treasuries, will re-inflate the housing bubble 
with even more liability for the taxpayer given the increase in 
federally guaranteed mortgages?

A.20. Of course, the Federal Reserve needs to be alert to the 
full range of potential consequences of our policies, and we 
will continue to carefully monitor conditions in housing 
markets. That said, however, the prospect of a re-ignited 
housing bubble does not seem likely in the period ahead. The 
demand for housing appears to be strengthening gradually, 
supported by a variety of factors including low mortgage 
interest rates for the most creditworthy borrowers, home prices 
that have fallen considerably from their peaks, and various 
government tax and credit initiatives. But by no means does 
this gradual improvement signal an overheating in housing 
markets. Nationally, house prices have declined 30 percent from 
their peak. Futures markets foresee only tepid increases over 
the next year; similarly, respondents to the Reuters University 
of Michigan survey of consumers expect at best sluggish 
appreciation. Home sales are still at comparatively low levels, 
and credit availability remains difficult for many borrowers, 
far different from the situation prior to the financial crisis. 
In addition, mortgage markets now operate under revised Federal 
Reserve regulations restricting certain unfair, abusive, or 
deceptive lending activities that contributed to the earlier 
excesses in the housing market. Finally, the large number 
offoreclosures that are likely to come on the market represents 
a significant potential source of downward pressure on house 
prices that may linger for some time.

Q.21. Mr. Chairman, as you know the FHA is insuring somewhere 
between 30 to 40 percent of the new home loans made in the 
country at the same time that its loan reserves are below 2 
percent and there is a real threat that the FHA runs out of 
money and has to come to Congress or the Treasury for an 
appropriation.
    What are the long term consequences of a mortgage market so 
heavily reliant on a guarantee by the Federal government?
    How do we transition back to a market without such a heavy 
reliance on the taxpayer?
    As a banking regulator, what views do you and the Federal 
Reserve have about the safety and soundness of loans made by 
banks with only a 3.5 percent downpayment? Should Congress be 
concerned that they are more risky than a loan made with a 10 
or 20 percent downpayment?

A.21. The FHA is currently serving an important role in 
supporting housing demand because it is the main source of 
finance for homebuyers with less than 20 percent downpayments. 
According to data from the National Association of Realtors, 
the typical first-time homebuyer over the past few years has 
had a down payment of less than 10 percent of the purchase 
price of the home. In addition, the FHA provides an outlet for 
borrowers seeking to refinance out of loans held in subprime or 
alt-A mortgage-backed securities who have seen their initial 
equity cushions decrease.
    As house prices stabilize over the next couple of years, 
outsized losses at mortgage insurance companies and banks--the 
traditional alternatives to FHA loans--should diminish. Once 
the effects of the extraordinary credit boom and bust of this 
decade start to wane, private lenders will again likely find it 
profitable to enter the market for higher LTV loans and the 
mortgage market should return to its traditional structure, 
where the FHA plays an important, but limited, role.
    Higher LTV loans, including FHA loans, are obviously more 
exposed to house price movements than loans where the borrower 
has made a large downpayment. As a result, it is particularly 
important that all lenders underwrite higher LTV loans with 
particular caution; for example, by carefully verifying the 
borrower's ability to repay and history of meeting credit 
obligations. (For banks, these risk mitigants, and other items, 
were contained in supervisory letters SR 06-15 and 07-12.)
    As always, banks, the FHA, the GSEs, and other institutions 
participating in the mortgage market should seek to accurately 
measure and appropriately price the risks they accept when 
making loans. For the FHA, the prudent underwriting of 
mortgages may also entail the development of new mortgage 
products and greater expenditures on technology and software 
resources that would allow it to better measure and manage its 
credit risk exposure. Otherwise, it may suffer from adverse 
selection as other lenders come back into the mortgage market.
              Additional Material Supplied for the Record
 [From The Washington Post, Thursday, December 3, 2009--Letter to the 
                            Editor, p. A32]
The Right Role for the Fed
    Regarding Federal Reserve Chairman Ben Bernanke's Nov. 29 Sunday 
Opinion commentary, ``The Right Reform for the Fed'':
    As a result of legislative convenience, bureaucratic imperative and 
historical happenstance, a variety of responsibilities have accreted to 
the Fed over the years. In addition to conducting monetary policy, the 
Fed also distributes currency, runs the system through which banks 
transfer funds, supervises financial holding companies and some banks, 
and writes rules to protect consumers in financial transactions. Mr. 
Bernanke argues that preserving this melange is not only efficient but 
crucial to protecting the Fed's independence.
    Apparently, the argument runs, there are hidden synergies that make 
expertise in examining banks and writing consumer protection 
regulations useful in setting monetary policy. In fact, collecting 
diverse responsibilities in one institution fundamentally violates the 
principle of comparative advantage, akin to asking a plumber to check 
the wiring in your basement.
    There is an easily verifiable test. The arm of the Fed that sets 
monetary policy, the Federal Open Market Committee (FOMC), has 
scrupulously kept transcripts of its meetings over the decades. (I 
should know, as I was the FOMC secretary for a time.) After a lag of 5 
years, this record is released to the public. If the FOMC made 
materially better decisions because of the Fed's role in supervision, 
there should be instances of informed discussion of the linkages. 
Anyone making the case for beneficial spillovers should be asked to 
produce numerous relevant excerpts from that historical resource. I 
don't think they will be able to do so.
    The biggest threat to the Fed's independence is doubt about its 
competence. The more the Congress expects the Fed to do, the more 
likely will such doubts blemish its reputation.

                                          Vincent Reinhart,
             Resident scholar at the American Enterprise Institute.
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