[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
Available at: http: //www.access.gpo.gov /congress /senate/
senate05sh.html
U.S. GOVERNMENT PRINTING OFFICE
54-239 PDF WASHINGTON : 2010
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Printing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; DC
area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC, Washington, DC
20402-0001
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.