    [Senate Hearing 111-772]
    [From the U.S. Government Publishing Office]

                                                            S. Hrg. 111-772

            FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2010

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

                                    HEARING

                                   before the

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

                         ONE HUNDRED ELEVENTH CONGRESS

                                 SECOND SESSION

                                       ON

      RECEIVING THE FEDERAL RESERVE'S SEMI-ANNUAL MONETARY REPORT TO THE
        CONGRESS AND DISCUSSING MONETARY POLICY AND THE ECONOMIC OUTLOOK

                                   __________

                               FEBRUARY 25, 2010

                                   __________

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

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

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                COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                   CHRISTOPHER J. DODD, Connecticut, Chairman

    TIM JOHNSON, South Dakota            RICHARD C. SHELBY, Alabama
    JACK REED, Rhode Island              ROBERT F. BENNETT, Utah
    CHARLES E. SCHUMER, New York         JIM BUNNING, Kentucky
    EVAN BAYH, Indiana                   MIKE CRAPO, Idaho
    ROBERT MENENDEZ, New Jersey          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 and Counsel

                         Marc Jarsulic, Chief Economist

                      Drew Colbert, Legislative Assistant

                    Misha Mintz-Roth, Legislative Assistant

                       Lisa Frumin, Legislative Assistant

                    Mark Oesterle, Republican Chief Counsel

                     Jeff Wrase, Republican Chief Economist

                    Andrew Olmem, Republican Senior Counsel

                Chad Davis, Republican Professional Staff Member

               Rhyse Nance, Republican Professional Staff Member

                    Laura Swanson, Professional Staff Member

                     Kara Stein, Professional Staff Member

                           Dawn Ratliff, Chief Clerk

                         Levon Bagramian, Hearing Clerk

                          Shelvin Simmons, IT Director

                              Jim Crowell, Editor

                                      (ii)
    ?

                                C O N T E N T S

                                  ----------

                          THURSDAY, FEBRUARY 25, 2010

                                                                       Page

    Opening statement of Chairman Dodd...............................     1
    Opening statements, comments, or prepared statement of:
        Senator Shelby...............................................     3

                                   WITNESSES

    Ben S. Bernanke, Chairman, Board of Governors of the Federal
      Reserve System.................................................     4
        Prepared statement...........................................    50
        Response to written questions of:
            Senator Shelby...........................................   109
            Senator Brown............................................   117
            Senator Merkley..........................................   122
            Senator Bunning..........................................   125

                                     (iii)

            FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2010

                                  ----------

                          THURSDAY, FEBRUARY 25, 2010

                                           U.S. Senate,
              Committee on Banking, Housing, and Urban Affairs,
                                                        Washington, DC.
        The Committee met at 9:08 a.m. in room SD-538, 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.
        Let me welcome all who are here this morning for the
    Committee hearing, the hearing on the semiannual monetary
    report to Congress by the Chairman of the Federal Reserve, and
    we welcome you once again, Mr. Chairman, to the Banking
    Committee. I will make a brief opening statement, turn to
    Senator Shelby for any comments he may make, and then we will
    turn right to you for your opening comments and get to some
    questioning. But we thank you once again for joining us here
    this morning.
        Today, as you testify before us, Mr. Chairman, it is worth
    taking a moment to recognize that our economy is showing signs
    of emerging from this recession. During the last two quarters,
    GDP has shown positive growth, as has gross private domestic
    investment, and financial markets have stabilized enough to
    allow the Fed to wind down nearly all the liquidity facilities
    it established in response to this crisis.
        But that does not mean, of course, that our economy is out
    of the woods, as we all know. And more importantly, it does not
    mean that the situation of working families has improved
    dramatically either. Households and small businesses dependent
    on banks for financing continue to have trouble getting the
    loans that they need. Commercial real estate losses continue to
    mount, and combined with losses on home mortgages, they are
    making the credit crunch even worse.
        Outside of securities guaranteed by the Federal Government,
    the residential and commercial markets for mortgage-backed
    securities are practically non-existent. Foreclosures continue
    to plague our communities at greater and greater rates, and the
    large inventory of foreclosed homes continues to suppress the
    housing market and discouraging new construction.
        And worst of all, Mr. Chairman, the job market continues to
    suffer from the losses incurred during the recession. We have
    lost 8.4 million jobs since December of 2007. The unemployment
    rate stands at 9.7 percent, although many of us would argue
    here that that number is actually vastly in excess of that in
    many areas of the country. And it is widely expected that it
    will remain high for several years to come. An astonishing 6.3
    million American workers have been out of a job for a half a
    year or more, and that is a record in our Nation.
        The state of our economy as a whole may be improving, but
    if we are talking about the situation of ordinary American
    families, I think I can sum up this recovery in three words:
    Not good enough. I think most would agree.
        The longer we go without resolving these problems, the
    worse off, of course, we all will be. Unemployed Americans will
    continue to lose their health insurance and their homes. Their
    skills will begin to deteriorate, leaving us less competitive
    in the global economy. Those who do have jobs will see their
    wages stagnate. Our country will suffer as a result.
        This Congress has a role to play in putting people back to
    work, and we have a responsibility to put protections in place
    to make sure that a crisis like this never threatens our
    financial system again. Our Committee has made important
    progress toward that end, and my hope is that we will have a
    financial reform bill ready in the coming days.
        Mr. Chairman, you also have a role to play in all of this,
    as you know, and I have been impressed by your leadership,
    keeping the American economy from falling into the abyss, and
    you deserve a great deal of credit, in my view, for having
    contributed so significantly to that result. But now it is time
    as well, as I am sure you will agree, for you to show the same
    kind of leadership in helping us and American families along
    with those of us on this side of the dais to achieve the same
    fate, to come out of this abyss and get back on our feet again.
        So I look forward to working with you in the coming days--I
    know all of my colleagues will--work on your ideas and how
    monetary policy can help our constituents emerge from this
    recession.
        Now, as many of my colleagues know, having filled in the
    seat for Ted Kennedy as Chairman of the Health, Education, and
    Labor Committee, I have another place to be this morning--at
    the White House--to sit there and resolve health care, which I
    am confident we are going to do this morning, I would say to my
    colleagues. I do not see any smiles around the table on hearing
    that prediction. And so I am going to be leaving shortly, but I
    want to take--I am going to abuse my chairmanship for a minute.
    I am going to ask you a question because I will not get a
    chance in the normal process.
        In light of what is happening in Greece, Mr. Chairman, I
    wanted to raise an issue because matters have arisen, and I
    will raise this and you can either respond quickly to it and I
    will go right to Senator Shelby. But if I indulge my colleagues
    by doing this--I have not done this before, but given that I
    have got the problems this morning where I have to be.
        The debt crisis, Mr. Chairman, in Greece is shedding light
    on the role of derivatives in the financial markets. According
    to news reports this morning and over the last several days,
    banks and hedge funds are using credit default swaps to bet
    that Greece will default on its debt. The rising price of these
    contracts contributes to an atmosphere of crisis, making it
    even more difficult for the Greek Government, in my opinion, to
    borrow. Since there is no requirement that purchasers of credit
    default swaps actually own any of the underlying debt, we have
    a situation in which major financial institutions are
    amplifying a public crisis for what would appear to be private
    gain.
        I want to ask you here whether or not you think there ought
    to be limits on the use of credit default swaps to prevent the
    intentional creation of runs against governments. Do you have
    any quick comments on that?
        Mr. Bernanke. Yes, Senator. I just want to say first of all
    that we are looking into a number of questions related to
    Goldman Sachs and other companies and their derivatives
    arrangements with Greece and on this issue as well. As you
    know, credit default swaps are properly used as hedging
    instruments.
        Chairman Dodd. I agree.
        Mr. Bernanke. The SEC, of course, has been interested in
    this issue. Obviously, using these instruments in a way that
    intentionally destabilizes a company or a country is
    counterproductive, and I am sure the SEC will be looking into
    that. We will certainly be evaluating what we can learn from
    the activities of the holding companies that we supervise here
    in the United States.
        Chairman Dodd. Well, let me just make the request of you
    here, and we will make the similar request to the SEC. I am
    sure all of us on this Committee would like to hear very
    quickly what the response is going to be, if any, either from
    your or recommendations you would make as well as from the SEC.
    I will make that formal request this morning. I think it is a
    critical issue for all of us.
        Senator Shelby.

                 STATEMENT OF SENATOR RICHARD C. SHELBY

        Senator Shelby. Thank you. Thank you, Chairman Dodd.
    Welcome to the Committee, Chairman Bernanke, again.
        As our financial markets began to show signs of
    improvement, many of the Fed's temporary lending facilities
    have been allowed to expire, and monetary policy has begun to
    normalize. And while use of the temporary lending facilities
    wane, expanded purchases by the Fed of Federal agency debt,
    mortgage-backed securities, and longer-term Treasury securities
    have kept the size of the Fed's balance sheet unusually large.
        As of last week, it is my understanding that the banks had
    over $1.2 trillion in reserve balances at Federal Reserve
    banks. That is more than 100 times the average level of such
    balances in 2006.
        This morning I am interested in hearing, Mr. Chairman,
    plans for reducing the size of the Fed's balance sheet,
    withdrawing extraordinary liquidity support from the banking
    system, and continuing the normalization of monetary policy. In
    addition, I believe, Mr. Chairman, you should tell us how the
    Fed plans to use interest on reserves as a monetary policy tool
    and how you intend to use reverse repurchase agreements to
    address reserves in the banking system.
        Finally, the Committee, I believe, should gain a better
    understanding of how the Fed and the Treasury Department intend
    to manage the Fed's balance sheet, and I think this is
    especially relevant given Tuesday's announcement by the
    Treasury that it anticipates selling securities and injecting
    around $200 billion into the Department's supplemental
    financing account at the Fed over the next 2 months.
        Mr. Chairman, while there are signs of improvement in the
    economy, conditions remain weak, especially in labor markets.
    Too many Americans are unemployed or underemployed. Because
    credible plans for fiscal balance and monetary policy are
    essential for economic recovery, we need to have transparency
    and clarity about the Federal Reserve's plans. My hope this
    morning, Mr. Chairman, is that you will provide that clarity.
        Thank you.
        Chairman Dodd. Mr. Chairman, the floor is yours.

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

        Mr. Bernanke. Thank you. Chairman Dodd, Ranking Member
    Shelby, and other members of the Committee, I am pleased to
    present the Federal Reserve's semiannual Monetary Policy Report
    to the Congress. I will begin today with some comments on the
    outlook for the economy and for monetary policy and then touch
    briefly on several important issues.
        Although the recession officially began more than 2 years
    ago, U.S. economic activity contracted particularly sharply
    following the intensification of the global financial crisis in
    the fall of 2008. Concerted efforts by the Federal Reserve, the
    Treasury Department, and other U.S. authorities to stabilize
    the financial system, together with highly stimulative monetary
    and fiscal policies, helped arrest the decline and are
    supporting a nascent economic recovery. Indeed, the U.S.
    economy expanded at about a 4-percent annual rate during the
    second half of last year. A significant portion of that growth,
    however, can be attributed to the progress that firms made in
    working down unwanted inventories of unsold goods, which left
    them more willing to increase production. As the impetus
    provided by the inventory cycle is temporary, and as the fiscal
    support for economic growth likely will diminish later this
    year, a sustained recovery will depend on continued growth in
    private sector final demand for goods and services.
        Private final demand does seem to be growing at a moderate
    pace, buoyed in part by a general improvement in financial
    conditions. In particular, consumer spending has recently
    picked up, reflecting gains in real disposable income and
    household wealth and tentative signs of stabilization in the
    labor market. Business investment in equipment and software has
    risen significantly. And international trade--supported by a
    recovery in the economies of many of our trading partners--is
    rebounding from its deep contraction of a year ago. However,
    starts of single-family homes, which rose noticeably this past
    spring, have recently been roughly flat, and commercial
    construction is declining sharply, reflecting poor fundamentals
    and continued difficulty in obtaining financing.
        The job market has been especially hard hit by the
    recession, as employers reacted to sharp sales declines and
    concerns about credit availability by deeply cutting their
    workforces in late 2008 and in 2009. Some recent indicators
    suggest that the deterioration in the labor market is abating:
    Job losses have slowed considerably, and the number of full-
    time jobs in manufacturing rose modestly in January. Initial
    claims for unemployment insurance have continued to trend
    lower, and the temporary services industry, often considered a
    bellwether for the employment outlook, has been expanding
    steadily since October. Notwithstanding these positive signs,
    the job market remains quite weak, with the unemployment rate
    near 10 percent and job openings scarce. Of particular concern,
    because of its long-term implications for workers' skills and
    wages, is the increasing incidence of long-term unemployment;
    indeed, more than 40 percent of the unemployed have been out of
    work for 6 months or more, nearly double the share of a year
    ago.
        Increases in energy prices resulted in a pickup in consumer
    price inflation in the second half of last year, but oil prices
    have flattened out over recent months, and most indicators
    suggest that inflation will likely remain subdued for some
    time. Slack in labor and product markets has reduced wage and
    price pressures in most markets, and sharp increases in
    productivity have further reduced producers' unit labor costs.
    The cost of shelter, which receives a heavy weight in consumer
    price indexes, is rising very slowly, reflecting high vacancy
    rates. In addition, according to most measures, longer-term
    inflation expectations have remained relatively stable.
        The improvement in financial markets that began last spring
    continues. Conditions in short-term funding markets have
    returned to near pre-crisis levels. Many (mostly larger) firms
    have been able to issue corporate bonds or new equity and do
    not seem to be hampered by a lack of credit. In contrast, bank
    lending continues to contract, reflecting both tightened
    lending standards and weak demand for credit amid uncertain
    economic prospects.
        In conjunction with the January meeting of the FOMC, Board
    members and Reserve Bank presidents prepared projections for
    economic growth, unemployment, and inflation for the years 2010
    through 2012 and over the longer run. The contours of these
    forecasts are broadly similar to those I reported to the
    Congress last July. FOMC participants continue to anticipate a
    moderate pace of economic recovery, with economic growth of
    roughly 3 to 3 \1/2\ percent in 2010 and 3 \1/2\ to 4 \1/2\
    percent in 2011. Consistent with moderate economic growth,
    participants expect the unemployment rate to decline only
    slowly, to a range of roughly 6 \1/2\ to 7 \1/2\ percent by the
    end of 2012, still well above their estimate of the long-run
    sustainable rate of about 5 percent. Inflation is expected to
    remain subdued, with consumer prices rising at rates between 1
    and 2 percent in 2010 through 2012. In the longer term,
    inflation is expected to be between 1 \3/4\ and 2 percent, the
    range that most FOMC participants judge to be consistent with
    the Federal Reserve's dual mandate of price stability and
    maximum employment.
        Over the past year, the Federal Reserve has employed a wide
    array of tools to promote economic recovery and preserve price
    stability. The target for the Federal funds rate has been
    maintained at a historically low range of 0 to \1/4\ percent
    since December 2008. The FOMC continues to anticipate that
    economic conditions--including low rates of resource
    utilization, subdued inflation trends, and stable inflation
    expectations--are likely to warrant exceptionally low levels of
    the Federal funds rate for an extended period.
        To provide support to mortgage lending and housing markets
    and to improve overall conditions in private credit markets,
    the Federal Reserve is in the process of purchasing $1.25
    trillion of agency mortgage-backed securities and about $175
    billion of agency debt. We have been gradually slowing the pace
    of these purchases in order to promote a smooth transition in
    markets and anticipate that these transactions will be
    completed by the end of March. The FOMC will continue to
    evaluate its purchases of securities in light of the evolving
    economic outlook and conditions in financial markets.
        In response to the substantial improvements in the
    functioning of most financial markets, the Federal Reserve is
    winding down the special liquidity facilities it created during
    the crisis. On February 1, a number of these facilities,
    including credit facilities for primary dealers, lending
    programs intended to help stabilize money market mutual funds
    and the commercial paper market, and temporary liquidity swap
    lines with foreign central banks, were all allowed to expire.
        The only remaining lending program for multiple borrowers
    created under the Federal Reserve's emergency authorities, is
    the Term Asset-Backed Securities Loan Facility, or TALF, and it
    is scheduled to close on March 31 for loans backed by all types
    of collateral except for newly issued commercial mortgage-
    backed securities, and it will close on June 30 for loans
    backed by newly issued CMBS.
        In addition to closing its special facilities, the Federal
    Reserve is normalizing its lending to commercial banks through
    the discount window. The final auction of discount window funds
    to depositories through the Term Auction Facility, which was
    created in the early stages of the crisis to improve the
    liquidity of the banking system, will occur on March 8. Last
    week, we announced the maximum term of discount window loans,
    which was increased to as much as 90 days during the crisis,
    would be returned to overnight for most banks, as it was before
    the crisis erupted in August 2007.
        To discourage banks from relying on the discount window
    rather than private funding markets for short-term credit, last
    week we also increased the discount rate by 25 basis points,
    raising the spread between the discount rate and the top of the
    target range for the Federal funds rate to 50 basis points.
    These changes, like the closure of most of the special lending
    facilities earlier this month, are in response to the improved
    functioning of financial markets, which has reduced the need
    for extraordinary assistance from the Federal Reserve. These
    adjustments are not expected to lead to tighter financial
    conditions for households and businesses and should not be
    interpreted as signaling any change in the outlook for monetary
    policy, which remains about the same as it was at the time of
    the January meeting of the FOMC.
        Although the Federal funds rate is likely to remain
    exceptionally low for an extended period, as the expansion
    matures, the Federal Reserve will at some point need to begin
    to tighten monetary conditions to prevent the development of
    inflationary pressures. Notwithstanding the substantial
    increase in the size of its balance sheet associated with its
    purchases of Treasury and agency securities, we are confident
    that we have the tools we need to firm the stance of monetary
    policy at the appropriate time.
        Most importantly, in October 2008 the Congress gave
    statutory authority to the Federal Reserve to pay interest on
    banks' holdings of reserve balances at Federal Reserve banks.
    By increasing the interest rate on reserves, the Federal
    Reserve will be able to put significant upward pressure on all
    short-term interest rates. Actual and prospective increases in
    short-term interest rates will be reflected in turn in longer-
    term interest rates and in financial conditions more generally.
        The Federal Reserve has also been developing a number of
    additional tools to reduce the large quantity of reserves held
    by the banking system, which will improve the Federal Reserve's
    control of financial conditions by leading to a tighter
    relationship between the interest rate paid on reserves and
    other short-term interest rates. Notably, our operational
    capacity for conducting reverse repurchase agreements, a tool
    that the Federal Reserve has historically used to absorb
    reserves from the banking system, is being expanded so that
    such transactions can be used to absorb large quantities of
    reserves. The Federal Reserve is also currently refining plans
    for a term deposit facility that could convert a portion of
    depository institutions' holdings of reserve balances into
    deposits that are less liquid and could not be used to meet
    reserve requirements. In addition, the FOMC has the option of
    redeeming or selling securities as a means of reducing
    outstanding bank reserves and applying monetary restraint. Of
    course, the sequencing of steps and the combination of tools
    that the Federal Reserve uses as it exits from its currently
    very accommodative policy stance will depend on economic and
    financial developments. I provided more discussion of these
    options and possible sequencing in a recent testimony.
        The Federal Reserve is committed to ensuring that the
    Congress and the public have all the information needed to
    understand our decisions and to be assured of the integrity of
    our operations. Indeed, on matters related to the conduct of
    monetary policy, the Federal Reserve is already one of the most
    transparent central banks in the world, providing detailed
    records and explanations of its decisions. Over the past year,
    the Federal Reserve also took a number of steps to enhance the
    transparency of its special credit and liquidity facilities,
    including the provision of regular, extensive reports to the
    Congress and the public; and we have worked closely with the
    GAO, the SIGTARP, the Congress, and private sector auditors on
    a range of matters relating to these facilities.
        While the emergency credit and liquidity facilities were
    important tools for implementing monetary policy during the
    crisis, we understand that the unusual nature of those
    facilities creates a special obligation to assure the Congress
    and the public of the integrity of their operation.
    Accordingly, we would welcome a review by the GAO of the
    Federal Reserve's management of all facilities created under
    emergency authorities. In particular, we would support
    legislation authorizing the GAO to audit the operational
    integrity, collateral policies, use of third-party contractors,
    accounting, financial reporting, and internal controls of these
    special liquidity and credit facilities. The Federal Reserve
    will, of course, cooperate fully and actively in all reviews.
    We are also prepared to support legislation that would require
    the release of the identities of the firms that participated in
    each special facility after an appropriate delay. It is
    important that the release occur after a lag that is
    sufficiently long that investors will not view an institution's
    use of one of these facilities as a possible indication of
    ongoing financial problems, thereby undermining market
    confidence in the institution or discouraging use of any future
    facility that might become necessary to protect the U.S.
    economy. An appropriate delay would also allow firms adequate
    time to inform investors through annual reports and other
    public documents of their use of Federal Reserve facilities.
        Looking ahead, we will continue to work with the Congress
    in identifying approaches for enhancing the Federal Reserve's
    transparency that are consistent with our statutory objectives
    of fostering maximum employment and price stability. In
    particular, it is vital that the conduct of monetary policy
    continue to be insulated from short-term political pressures so
    that the FOMC can make policy decisions in the longer-term
    economic interests of the American people. Moreover, the
    confidentiality of discount window lending to individual
    depository institutions must be maintained so that the Federal
    Reserve continues to have effective ways to provide liquidity
    to depository institutions under circumstances where other
    sources of funding are not available. The Federal Reserve's
    ability to inject liquidity into the financial system is
    critical for preserving financial stability and for supporting
    depositories' key role in meeting the ongoing credit needs of
    firms and households.
        Strengthening our financial regulatory system is essential
    for the long-term economic stability of the Nation. Among the
    lessons of the crisis are the crucial importance of
    macroprudential regulation that is, regulation and supervision
    aimed at addressing risks to the financial system as a whole--
    and the need for effective consolidated supervision of every
    financial institution that is so large or interconnected that
    its failure could threaten the functioning of the entire
    financial system.
        The Federal Reserve strongly supports the Congress' ongoing
    efforts to achieve comprehensive financial reform. In the
    meantime, to strengthen the Federal Reserve's oversight of
    banking organizations, we have been conducting an intensive
    self-examination of our regulatory and supervisory
    responsibilities and have been actively implementing
    improvements. For example, the Federal Reserve has been playing
    a key role in international efforts to toughen capital and
    liquidity requirements for financial institutions, particularly
    systemically critical firms, and we have been taking the lead
    in ensuring that compensation structures at banking
    organizations provide appropriate incentives without
    encouraging excessive risk taking.
        The Federal Reserve is also making fundamental changes in
    its supervision of large, complex bank holding companies, both
    to improve the effectiveness of consolidated supervision and to
    incorporate a macroprudential perspective that goes beyond the
    traditional focus on safety and soundness of individual
    institutions. We are overhauling our supervisory framework and
    procedures to improve coordination within our own supervisory
    staff and with other supervisory agencies and to facilitate
    more integrated assessments of risks within each holding
    company and across groups of companies.
        Last spring the Federal Reserve led the successful
    Supervisory Capital Assessment Program, popularly known as the
    bank stress tests. An important lesson of that program was that
    combining onsite bank examinations with a suite of quantitative
    and analytical tools can greatly improve comparability of the
    results and better identify potential risks. In that spirit,
    the Federal Reserve is also in the process of developing an
    enhanced quantitative surveillance program for large bank
    holding companies. Supervisory information will be combined
    with firm-level, market-based indicators and aggregate economic
    data to provide a more complete picture of the risks facing
    these institutions and the broader financial system. Making use
    of the Federal Reserve's unparalleled breadth of expertise,
    this program will apply a multidisciplinary approach that
    involves economists, specialists in particular financial
    markets, payments systems experts, and other professionals, as
    well as bank supervisors.
        The recent crisis has also underscored the extent to which
    direct involvement in the oversight of banks and bank holding
    companies contributes to the Federal Reserve's effectiveness in
    carrying out its responsibilities as a central bank, including
    the making of monetary policy and the management of the
    discount window. But most important, as the crisis has once
    again demonstrated, the Federal Reserve's ability to identify
    and address diverse and hard-to-predict threats to financial
    stability depends critically on the information, expertise, and
    powers that it has by virtue of being both a bank supervisor
    and a central bank.
        The Federal Reserve continues to demonstrate its commitment
    to strengthening consumer protections in the financial services
    arena. Since the time of the previous Monetary Policy Report in
    July, the Federal Reserve has proposed a comprehensive overhaul
    of the regulations governing consumer mortgage transactions,
    and we are collaborating with the Department of Housing and
    Urban Development to assess how we might further increase
    transparency in the mortgage process. We have issued rules
    implementing enhanced consumer protections for credit card
    accounts and private student loans as well as new rules to
    ensure that consumers have meaningful opportunities to avoid
    overdraft fees. In addition, the Federal Reserve has
    implemented an expanded consumer compliance supervision program
    for nonbank subsidiaries of bank holding companies and foreign
    banking organizations.
        More generally, the Federal Reserve is committed to doing
    all that can be done to ensure that our economy is never again
    devastated by a financial collapse. We look forward to working
    with the Congress to develop effective and comprehensive reform
    of the financial regulatory framework.
        Thank you.
        Senator Johnson. [Presiding.] Thank you, Mr. Chairman.
        Is there an agreement that 5 minutes should be enough on
    the clock? I do not want to be overly rigid, but so be it.
        Chairman Bernanke, the weather has been unusually harsh
    across the country in the past month. This has disrupted
    business and Government activity and is likely to have an
    impact on employment. Do you think the effects will be strong
    enough to show up in the next month's employment statistics?
        Mr. Bernanke. Senator, first I would say that the harsh
    weather will not have permanent effects on the----
        Senator Bunning. Turn on your microphone.
        Mr. Bernanke. Pardon me. Senator, I would like to say first
    that the harsh weather is unlikely to have any permanent
    effects on the economy, simply a temporary effect. But it does
    seem likely that there will be some impact on the employment
    statistics for January. It is very hard to know exactly how
    much, but the snowstorms were during the week in which the
    information is gathered about payrolls. It may also affect
    unemployment insurance claims and some other kinds of
    information. So we will have to be particularly careful about
    not overinterpreting the data that we receive for January.
        Senator Johnson. As Congress grapples with the need for job
    creation and the need to reduce our mounting deficits and
    national debt, can you talk about the impact unemployment and
    the budget imbalance could have on inflation?
        Mr. Bernanke. Well, currently Senator, inflation looks to
    be subdued. We are not expecting inflation to rise
    significantly in the near or medium term.
        On the one hand, the unemployment and the low use,
    utilization, the low rate of utilization of labor has been a
    force keeping wage gains very lower, which, of course, from a
    worker' perspective is a problem. From the perspective of
    employers, they are seeing both very slow wage growth and
    because of all the cuts and cost-cutting measures, they are
    also seeing very strong increases in productivity, which are
    quite remarkable. So the combination of slow wage growth and
    high productivity gains means that the unit labor costs, the
    costs of production are, if anything, falling for most firms.
    So that, together with very weak demand in many industries,
    means that firms have very little ability or incentive to raise
    prices, which would, of course, tend to moderate inflation.
        On the deficit, the impact on inflation in the near term I
    think is limited. Of course, it is important that Congress, the
    Administration, find solutions to our longer-term debt
    problems. Otherwise, it is conceivable--and I am not
    anticipating anything in the near term, but it is conceivable
    that it could lead to a loss of confidence in aspects of the
    U.S. economy. It could affect interest rates. It could affect
    the value of the dollar. And those things could directly or
    indirectly affect the state of the economy, the recovery, and,
    of course, the rate of inflation.
        Senator Johnson. As the Federal Reserve begins to wind down
    purchases of mortgage-backed securities, what steps, if any,
    are needed to ensure stability in the housing market during
    this transition?
        Mr. Bernanke. Well, as you know, Senator, we are at this
    point planning to end our purchases at the end of this first
    quarter. A question is to what extent will mortgage rates be
    affected by the end of our purchases. Of course, even though we
    have stopped purchases, we still retain on our balance sheet
    $1.25 trillion of mortgage-backed securities, and we believe
    that the holding of all those securities off the market in
    itself will tend to keep mortgage rates down.
        We do not know for sure how much mortgage rates will
    respond to our leaving the market. So far, there is little
    evidence of much change in mortgage rates, but obviously, we
    have to keep monitoring that. If there is a response which
    seems to threaten the broader economic recovery, we certainly
    would be prepared to review that decision. But, again, at the
    moment it does not seem to be that a large change in mortgage
    rates or any effect on housing is evident.
        Senator Johnson. Although the minutes of the January 26-27,
    2010 Federal Open Market Committee meeting indicate that core
    measures of inflation have been stable, they also indicate that
    headline inflation with swings in energy prices and core
    inflation may have been held down by unusually slow increases
    in the price index for shelter due to the housing crisis. Do
    you think that potentially higher future energy and housing
    costs pose an inflationary threat in the medium run?
        Mr. Bernanke. Well, we believe that the underlying trend of
    inflation, given stable expectations, given a very weak
    economy, looks to be subdued. Of course, we monitor energy and
    commodity prices very closely and they can vary substantially
    depending, for example, on the strength of the global recovery.
    Recently, energy prices have been roughly stable and futures
    prices don't indicate an expectation of sharp increases in the
    near term. So, again, we will continue to monitor energy
    prices, but currently, at least, they are not presenting a
    major inflationary threat.
        The very high vacancy rates in rental properties are
    keeping rents down, as well as vacancies in homes, as well, and
    our anticipation is that shelter costs are going to remain
    quite subdued for some time.
        Senator Johnson. Senator Shelby.
        Senator Shelby. Thank you.
        Chairman Bernanke, this Committee continues, as you well
    know, to wrestle with financial reform and the role of the Fed
    has been a significant part of that debate, as you are well
    aware. Chairman Dodd has previously proposed stripping the Fed
    of its regulatory authority, allowing you and your colleagues
    to focus on your monetary policy, lender of last resort, and
    payment systems functions and so forth. On the other hand, some
    on the Committee have argued in favor of allowing the Fed to
    retain some type of regulatory authority over the largest
    institutions, perhaps some of the others.
        What do you see--how do you see such an approach, as a net
    positive or a net negative here, and what would you do as
    Chairman of the Board of Governors of the Fed if the will of
    the Congress was to give the Fed another opportunity to be a
    regulator? What would you change, considering all the problems
    that were had in the last 7 years in the regulatory process?
        Mr. Bernanke. Thank you, Senator. As you know, I think that
    stripping the Federal Reserve of its supervisory authorities in
    the light of the recent crisis would be a grave mistake for
    several reasons.
        First, we have learned from the crisis that large, complex
    financial firms that pose a threat to the stability of the
    financial system need strong consolidated supervision. That
    means they need to be seen and overseen as a complete company,
    reflecting the developments not only in their banks, but also
    in their securities dealers and all the various aspects of
    their operations.
        A bank supervisor which focuses on looking at credit files
    is not prepared to look at the wide range of activities of a
    complex international financial firm. The Federal Reserve, in
    contrast, by virtue of its efforts in monetary policy, has
    substantial knowledge of financial markets, payment systems,
    economics, and a wide range of areas other than just bank
    supervision, and in our stress test, we demonstrated that we
    can use that whole range of multidisciplinary skills to do a
    better job of consolidated oversight.
        By the same token, we need to look at systemic risks.
    Systemic risks themselves also involve risks that can span
    across companies and into various markets. There again, you
    need an institution that has a breadth of skills. It is hard
    for me to understand why in the face of a crisis that was so
    complex and covers so many markets and institutions you would
    want to take out of the regulatory system the one institution
    that has the full breadth and range of those skills to address
    those issues.
        Let me mention your second point, and I think your point is
    very well taken. As I discussed in my testimony, we have taken
    very, very seriously both changes in our performance, changes
    in the way we go about doing supervision, but also changes in
    the structure of supervision, and we have made very substantial
    changes in order to increase the quality of our supervision, to
    increase our ability to look for systemic risks, and to use a
    multidisciplinary cross-expertise platform to look at these
    different issues. So we are very committed, and I would be
    happy to discuss with you through a letter or individually more
    details.
        I guess I would also like, if I might just have one more
    second, the Federal Reserve, of course, made errors and made
    mistakes in the supervisory function, but we were hardly alone
    in that respect and there were----
        Senator Shelby. But what have you learned? I guess that is
    the question.
        Mr. Bernanke. Well, my----
        Senator Shelby. You and the Board of Governors. What have
    you learned?
        Mr. Bernanke. We have learned several things. We have
    learned, first, that regulations need to be tougher, and we
    have led the effort to strengthen capital requirements, to
    strengthen liquidity requirements, to put more controls, risk
    controls into these companies. We have learned that we need to
    have a more risk and systemic-oriented approach and we have
    changed our approach to do that. So we have gone at this very
    extensively.
        Senator Shelby. Mr. Chairman, I want to briefly get into
    the Volcker Rule and size limits. The Administration recently
    proposed, as you well know, that limitations be imposed on
    banks and bank holding companies with respect to trading
    activities, including proprietary trading, the so-called
    Volcker Rule. The Administration also proposed placing
    limitations on what was referred to as, quote, ``excessive
    growth'' of the shares of liabilities at the largest financial
    firms.
        What are your views on the Volcker Rule proposal, and
    separately, on the proposal to limit excessive growth in the
    firms' liabilities? And do the regulators right now have the
    power, as some people have suggested, to invoke the Volcker
    Rule, or would you need legislation if the Congress so thought
    it was necessary?
        Mr. Bernanke. Senator, first, I think we would all agree
    that we don't want companies taking excessive risks when they
    are protected by the government safety net, so that is very
    important. There are obviously multiple ways to address those
    risks and they include capital requirements, and we have
    increased capital requirements, as well as, for example,
    restrictions on executive compensation, which affect
    willingness to take risks.
        If you go about imposing the Volcker Rule, I think it would
    be difficult to do on a purely legislative basis because of the
    potential for having unintended consequences. So while on the
    one hand you may want to restrict purely proprietary trading,
    you also want to distinguish that from, say, appropriate
    hedging behavior----
        Senator Shelby. You have to be careful, don't you?
        Mr. Bernanke. You have to be careful of unintended
    consequences. Hedging, market making, customer activities can
    involve ownership of securities for a period of time. I do
    think if you want to go in that direction, you should at least
    allow some role for the supervisors to make determinations
    about individual activities. I think it would not be
    inappropriate if a supervisor determines that a company doesn't
    have the managerial or risk capacity to appropriately manage a
    particular activity, for the supervisor to be able to restrict
    that activity.
        I would argue that we have that authority to some extent
    now, but if Congress wants to reinforce that, of course, it
    couldn't hurt.
        Senator Shelby. Thank you, Mr. Chairman.
        Senator Johnson. Senator Reed?
        Senator Reed. Thank you very much, Mr. Chairman, and
    welcome, Chairman Bernanke.
        A follow-up on the Volcker Rule. How would you implement it
    if you were to do it through your regulatory process?
        Mr. Bernanke. We would do it as part of our overall risk
    management assessment. We would look at the range of activities
    that the company engages in. There might be some activities
    that would be explicitly prohibited by legislation, say perhaps
    owning a hedge fund, for example. But if there are other
    activities, such as purchasing of, say, credit default swaps, I
    think it would be appropriate for the supervisor to, first of
    all, ascertain that the use of credit default swaps is
    primarily intended to hedge other positions and therefore is
    overall a net reduction in risk for the company as opposed to
    an increase or a speculative increase in risk.
        Second, even if the purposes of the program are in some
    sense legitimate, there is still the question of whether the
    company has adequate managerial risk management resources to
    properly manage those risks, and what we saw in the previous
    crisis, and I think this is one of the things we really
    learned, is that many large, complex companies didn't really
    understand the full range of risks that they were facing and as
    a result they found themselves exposed in ways they didn't
    anticipate. So if a company didn't have strong risk management
    controls and a strong culture of system--enterprise-wide risk
    management, I think that would be also grounds for the
    supervisor requesting either substantial strengthening in those
    controls or eliminating those activities.
        Senator Reed. Just an observation. Those controls are much
    more rigorous today, but they tend to erode over time,
    particularly as these unpleasant crises fade. And also, the
    capacity of the regulators, the Federal Reserve and other
    regulators, to make very nuanced judgments about management, et
    cetera, there is really a question of regulatory capacity as
    well as managerial capacity that at least the last several
    months suggests that it won't be handled by simply sort of
    letting you do what you inherently can do now.
        Mr. Bernanke. Well, certainly Congress could provide
    guidance about what they would like to see shut down or make
    specific statutory recommendations or statutory laws. But
    another--I am sorry. I lost my train of thought.
        Oh, yes, sorry. I just recalled. I think another part of
    the reform package that is very important is the resolution
    authority and measures taken to address the too-big-to-fail
    problem. If you can address the too-big-to-fail problem and get
    market discipline affecting firms so that investors will have
    an incentive to try to evaluate the risk taking of those firms,
    that will be an additional--not a panacea, but it will be an
    additional factor helping the regulators and the firm itself
    make good decisions.
        Senator Reed. Underlying this discussion of the Volcker
    Rule is a more general principle, I think. That is, what risks
    should taxpayers support? I think there is a consensus that
    traditional commercial banking, which everything has a risk,
    has historically been supported and should be supported. But
    the ability to access your credit facilities and your authority
    under 13(3) by large financial institutions whose primary
    activity is not commercial banking but either proprietary
    trading, which is inherently riskier, I mean, there is a real
    question here of whether they should have that access and I
    think that is at the heart of the Volcker Rule.
        To your point about too big to fail, I mean, the size has
    not been indicative of the sort of capacity to fail, so again,
    I just--there are real questions that we have to wrestle with
    with respect to, as a policy that you will implement, whether
    we are going to, with taxpayers' money, support very profitable
    risk-taking activities when they work and catastrophic
    activities to taxpayers when they don't work.
        Mr. Bernanke. Well, Senator, as an example, consider the
    savings and loans, which basically were killed by interest rate
    risk. Today, they would either be able to securitize the loans
    that they made or they would be able to hedge that interest
    rate risk.
        So I am not disagreeing with you at all. I think we all
    agree that we don't want excessive risk taking, particularly on
    a ``tails, I win, heads, you lose'' basis, certainly. But there
    are some legitimate purposes for using securities and we just
    want to make sure not to increase the risk----
        Senator Reed. No, I recognize the difficulty of sorting out
    a proprietary trade. You don't have the staff, frankly, to do
    that, to keep up with every trading platform and every trading
    floor in the country. So that is why I think there has to be
    perhaps a simpler approach, since these organizations are so
    large in terms of their trading versus the commercial banks,
    they might not qualify for the same type of support.
        Thank you.
        Senator Johnson. Senator Bunning?
        Senator Bunning. Thank you, Mr. Chairman. Thank you for
    being here.
        On the discount rate increase, how much lending is
    currently outstanding at the discount window? I don't want to
    know the people, I just want to know the amounts.
        Mr. Bernanke. I believe it is in the order of $17 to $20
    billion.
        Senator Bunning. OK. If that is the case, since there is so
    little discount window borrowing going on, the increase in the
    discount rate seems to be more for show than for substance. On
    top of that, you and the Fed have gone out of your way to
    downplay the importance of that move. Why should anyone take
    that move as a sign that you are serious about taking away the
    punch bowl at this time?
        Mr. Bernanke. Well, Senator, what we have been trying to do
    is to eliminate the extraordinary support that we have provided
    financial markets, and we had a wide range of programs that try
    to address the dysfunction in the commercial paper market,
    money market mutual funds, interbank markets, repo markets, and
    a variety of others. And as I mentioned in my testimony, on
    February 1, we shut down most of those programs. By June, we
    will have no more of these 13(3) programs----
        Senator Bunning. Except--except what Senator Shelby brought
    up. On Tuesday, the Treasury announced that they were starting
    up a supplemental financing program again. It is $200 billion-
    plus. Under that program, Treasury issues debts and deposits
    the cash with the Fed. That is the effective same thing as the
    Fed issuing its own debt, which you know is not legal.
        Mr. Bernanke. What it does----
        Senator Bunning. There are--well, let me finish with the
    question and you can answer. What are the legal grounds that
    the Fed and Treasury used to justify that program? And did
    anyone in the Fed or Treasury object when the program was
    created?
        Mr. Bernanke. Well, legally, we are the fiscal agent of the
    Treasury and we hold Treasury balances that they--for all kinds
    of purposes, so there is no----
        Senator Bunning. But they are not allowed to issue debt,
    Treasury.
        Mr. Bernanke. Treasury is allowed to issue debt.
        Senator Bunning. On its own?
        Mr. Bernanke. I don't--they issue bills and other kinds of
    debt all the time.
        Senator Bunning. Oh, yes, Treasury notes, Treasury bills,
    Treasury 2-years, 5-years, 10-years. But you are buying--you
    buying their debt.
        Mr. Bernanke. We are just paying them interest on their
    deposits on our balance sheet.
        Senator Bunning. OK. That isn't the answer that I wanted.
        Given what you learned during the AIG crisis and the
    bailout, do you think Congress should be doing something to
    address insurance regulation or the commercial paper markets?
        Mr. Bernanke. Well, Senator, I think AIG is the poster
    child for, first, consolidated supervision. It did not have a
    strong consolidated supervisor that was paying attention to its
    derivatives activities, for example. That is very important to
    do. Second----
        Senator Bunning. Were those the ones in England?
        Mr. Bernanke. No, those were the ones, the CDS--the credit
    default swaps that the Financial Products Division was
    exposed----
        Senator Bunning. Weren't they located in London?
        Mr. Bernanke. Well, they were in any case accessible to
    U.S. regulators.
        Senator Bunning. I didn't ask that question. I said, but
    didn't AIG have an office in London that did those things?
        Mr. Bernanke. It had some foreign offices, but I believe
    that the Financial Products Division is headquartered in
    Connecticut.
        Senator Bunning. OK. Go right ahead.
        Mr. Bernanke. So again, to address AIG issues, you need a
    strong consolidated supervisor that can identify those kinds of
    risks to the company and you also need some methodology, and I
    think you would agree that we don't want to have too-big-to-
    fail firms. We don't want the Fed involved in these bailouts.
    So you need an alternative legal structure. We have supported a
    resolution regime. I know this Committee is considering
    alternatives that would allow the government, excluding the
    Fed, to wind down a firm like this in a crisis in a way that
    would not bring down the overall financial system. I think that
    is a very important direction.
        Senator Bunning. Does any other Fed Governor have their own
    staff?
        Mr. Bernanke. The staff of the Federal Reserve works for
    all the Governors. There is no----
        Senator Bunning. That is not my question.
        Mr. Bernanke. The staff--no, not dedicated, except for
    clerical----
        Senator Bunning. OK. Do you think they should?
        Mr. Bernanke. No. I think we all work collectively and we
    all get the support from the entire staff.
        Senator Bunning. Do Fed Governors have access to the
    Board's staff recommendations or do they only get to see the
    recommendations you approve of?
        Mr. Bernanke. They see the staff recommendations.
        Senator Bunning. They do?
        Mr. Bernanke. Yes.
        Senator Bunning. Have you ever tried to change or influence
    staff recommendations before they were presented to the Board?
        Mr. Bernanke. Not final recommendations, no.
        Senator Bunning. Your e-mails tell us differently.
        Mr. Bernanke. You are referring to an e-mail where a
    preliminary draft by a couple of economists----
        Senator Bunning. It was the Fed staff. That is what the----
        Mr. Bernanke. It was Fed staff, but it wasn't the Fed
    staff's recommendation because it was a draft done by several
    people in the division, not by the leadership of the staff. And
    it was, in any case, a recommendation that was outdated because
    of changes in circumstances.
        Senator Bunning. That was in your opinion.
        Mr. Bernanke. Yes, sir.
        Senator Bunning. I have more, but I am past my time.
        Senator Johnson. Senator Akaka?
        Senator Akaka. Thank you very much, Mr. Chairman.
        I want to welcome Chairman Bernanke back to the Committee
    and also to congratulate and welcome him and wish him well in
    his continued tenure as Chairman of the Board of Governors of
    the Federal Reserve System. We both share a commitment to
    improving the lives of working families by better educating,
    protecting, and empowering consumers.
        Chairman Bernanke, Chairman Dodd and other Members of this
    Committee helped develop and enact meaningful card reform
    legislation. I am proud that the law includes provisions from
    my Credit Card Minimum Payment Warning Act which will provide
    consumers with detailed personalized information on their
    billing statements and access to reputable credit counseling
    services. Consumers will learn the true costs of making the
    minimum payments and how long it will take for them to pay off
    their balance if they only make minimum payments. Consumers are
    also provided with the amount that they need to pay to
    eliminate their outstanding balance within 36 months, which is
    the typical length of a debt management plan. This useful
    information recently started appearing on statements, and I
    looked at it and was happy to see it.
        My question to you is, how will the personalized credit
    card minimum payment information influence the behavior of
    consumers, and also what additional personalized disclosures
    pertaining to other financial service products would enable
    consumers to make better informed choices?
        Mr. Bernanke. Well, Senator, I congratulate you on those
    contributions. As you know, the Federal Reserve developed
    extensive disclosures for credit cards as well as some rules
    which were very extensively incorporated in the Congressional
    bill that passed and was signed by the President.
        Obviously, as you point out, the more information you can
    provide consumers, the better decisions they can make and the
    kinds of information about minimum balances, time to pay off,
    the cost of the card, the penalties they might face, those are
    the kinds of things people need to shop. If they can shop, the
    market becomes more competitive and you get a market that
    better serves consumers.
        We have been very focused on good disclosures, good
    information. We have in our disclosure reform that we did
    earlier, we--I don't see Senator Schumer here yet today, but
    there is the so-called Schumer Box, which has----
        Senator Bunning. He is at the White House.
        Mr. Bernanke.----has a list of key features of the account.
    We have done a lot of work on that to make it easier to read
    and more understandable to consumers.
        One of the innovations pioneered by the Federal Reserve has
    been to use consumer testing. We have gone out and instead of
    having some lawyers just sort of figure out what should be in
    the disclosure, we have actually gone out to shopping malls and
    had people look at the disclosures and then we have tested them
    to see how much they understand and retain. And by doing that,
    we think we are improving considerably the ability of folks to
    understand what they are buying and encouraging them to shop
    around to get a better deal.
        So again, I congratulate you on your contributions to this
    and on your longstanding support for financial literacy and for
    clear disclosures.
        Senator Akaka. Mr. Chairman, unfortunately, investment
    banks, credit card issuers, and predatory lenders through their
    excessive bonuses and unfair treatment of consumers are giving
    the term ``bank'' an even greater negative connotation. I am
    afraid that abused or angry consumers may continue to
    underutilize mainstream financial institutions. After having
    grown up in an unbanked home, I personally know the challenges
    that confront the unbanked. Many community banks and credit
    unions provide vital financial services to working families by
    providing opportunities for savings, borrowing, and low-cost
    remittances.
        The question is, why is it essential that we attempt to
    encourage the unbanked and the underbanked to utilize
    mainstream financial institutions more?
        Mr. Bernanke. Well, Senator, as you well know, for various
    reasons, lack of information, cultural reasons, and so on, many
    minority or immigrant communities don't make much use of the
    regular banking system. The cost of that is they may find
    themselves paying much more for check cashing or for short-term
    borrowing or for other services that they need. In most cases,
    they would be better off in a mainstream financial institution.
        We have encouraged banks, credit unions, and other
    financial institutions to reach out to minority neighborhoods
    by, for example, having people on staff who speak the language,
    through advertising and through other activities, through the
    CRA, the Reinvestment Act. By doing that, you attract people
    from these communities and give them access to the broader
    financial network. It helps them not only to get better deals
    on their financial services, to pay less for check cashing, for
    example, but it also helps them begin to learn how to save or
    learn how to borrow for a home and do other things that you
    need to have access to the broad mainstream financial system in
    order to achieve.
        So I think it is very important that mainstream financial
    institutions continue to reach out to people in their
    communities, including minorities and immigrants, to attract
    them to use of mainstream financial services.
        Senator Akaka. Thank you. Thank you very much, Mr.
    Chairman.
        Senator Johnson. Senator Johanns?
        Senator Johanns. Thank you, Mr. Chairman. Mr. Chairman,
    good to see you again.
        Mr. Chairman, let me start out and say that I think we have
    done some good work as we have tried to move through regulatory
    reform. I think everybody, quite honestly, has learned from the
    mistakes of the last years, no doubt about that. But I must
    admit, I have a concern about something that I think is shared
    by probably everybody here. It may be a little sensitive, but I
    want to ask about it, and that is Fannie and Freddie.
        We have spent a lot of time talking about too big to fail
    and looking at private companies and how gigantic they had
    gotten and how that really put us in a box. In the end, the
    taxpayers got put on the hook for that. Isn't Fannie and
    Freddie the government version of that too big to fail? And how
    do you get out of that box?
        Mr. Bernanke. Well, Senator, first, as I am sure you know,
    the Federal Reserve has a long record of warning about the
    dangers of the structure of Fannie and Freddie. There are
    numerous dangerous, including conflicts of private and public
    interest, and most notably, insufficient capital to support the
    very large portfolios that they held. And, in fact, it turned
    out they didn't have enough capital and now the U.S.
    Government, the taxpayer, is subject to substantial cost.
        Right now, we are kind of in no man's land. Fannie and
    Freddie are in conservatorship. They are part of the
    government's efforts to maintain the housing market because
    there really is no other source of mortgages at this point, or
    mortgage securitization. But certainly, this is not a
    sustainable situation and I think it is very important that we
    move toward clarifying the longer-term status.
        There are numerous ways to go. I have talked about some in
    a speech. But to give two examples, one would be a
    privatization approach, which might allow the privatized firms
    that securitize mortgages to purchase insurance from the
    government for the mortgages that they package and sell.
        Another possibility would be just to acknowledge that these
    are government utilities and incorporate them with Ginnie and
    FHA and other government agencies. So those are two very
    different approaches, but both of them have the advantage of
    eliminating this platypus kind of, you know, neither fish nor
    fowl status that those firms have now.
        Senator Johanns. Neither approach will eliminate the
    exposure that the taxpayer faces. Would you agree with me
    there?
        Mr. Bernanke. Well, for example, if you had a situation
    where privatized firms were not allowed to hold large
    portfolios, which is a major source of the risk, first; and,
    second, that they paid actuarially fair premiums to the
    Government as opposed to the implicit support they had before,
    there would still be risks to the taxpayer, but at least there
    would be some compensation, some premium is being collected.
        Senator Johanns. In effect, it sounds to me like a
    Government liquidation, and I do not know that I would want to
    personally buy into that. But I guess as a taxpayer we would
    all end up buying into that. But it is a huge number, isn't it?
    It is probably $1 trillion plus of exposure.
        Mr. Bernanke. Well, it depends how you count exposure. Of
    course, the mortgage-backed securities outstanding are in the
    trillions.
        Senator Johanns. Yes.
        Mr. Bernanke. The Government's commitment at this point is
    a couple hundred billion to those institutions.
        Senator Johanns. Let me also draw your attention to
    something, and I am running out of time here, but I was just
    catching up on some things, and I noticed today that first-time
    unemployment filings have increased. That was not expected.
    Durable goods orders have fallen the most since August. That is
    not a good sign. And that excludes, I think, transportation.
        The market has responded by dropping at least at this point
    by 160, and I appreciate the market can have up days and down
    days. I am starting to read more and more articles about the
    national debt interfering with economic recovery. And yet I do
    not see an effort to slow that down here.
        In fact, if we were just to stand down and say, OK, we will
    adopt the President's plan, there are trillion dollar deficits
    over the next decade. I cannot imagine how that turns out for--
    you know, I will be 70 years old the next decade. I am not
    going to live long enough to pay that off. That means my
    children and grandchildren are going to have to deal with that.
        I am beginning to wonder, Mr. Chairman--and I do not want
    this to sound overly pessimistic, but I am beginning to wonder
    whether low interest rates really have any possibility of
    spurring this economy. And I will tell you what I am thinking
    about, and you may not even have enough time to respond. Unless
    there is demand, unless we can get consumers back into it, it
    just seems very unlikely to me that you are going to see much
    growth.
        I talked to people who handle the freight--the railroads,
    the trucking companies. They are not seeing much improvement.
    All these signs point to a situation where, quite honestly,
    this economy is still enormously flat. And I am not sure that
    offering somebody an interest rate at 2 percent versus 4
    percent is going to get us on the other side of this, and I
    would just like your thought on that.
        Mr. Bernanke. Well, first, I agree that the economy is
    still very weak and very disappointing in that respect. I think
    low interest rates do tend to help, and I will give you a
    couple of examples.
        One, you mentioned the durable goods. Notwithstanding--I
    have not had a chance to get into those numbers in detail this
    morning, but investment, actually equipment investment,
    equipment and software investment has been something of a
    bright spot and has been growing. And part of the reason for
    that is that larger firms at least have pretty good access to
    credit at reasonable rates in the corporate bond market, for
    example, and that has supported the investment rebound, which
    is a big part of what we are seeing in the recovery.
        Another example is that the Fed's actions, interest rate
    actions and our purchases of mortgage-backed securities, have
    helped bring down mortgage rates. That has helped to some
    extent to stabilize demand for housing and helped--as you may
    know, house prices seem to have flattened out and begun to rise
    a bit, which is very important for consumers in terms of their
    wealth, in terms of the risk of foreclosure, and in terms of,
    you know, restarting activity in the residential construction
    sector.
        So those are two examples where we see growth. We did have
    4-percent growth in the second half of 2009. I think the issue
    we face is will the growth be fast enough to materially reduce
    the unemployment rate at a pace that we would like to see, and
    that is a big uncertainty right now. But we are getting some
    output growth at this point.
        Senator Johanns. Mr. Chairman, thank you.
        Senator Johnson. Senator Brown.
        Senator Brown. Thank you, Mr. Chairman. Mr. Chairman, nice
    to see you.
        We all know for most of our Nation's history--I am going to
    go in a bit different direction. For most of our Nation's
    history, manufacturing and agriculture and transportation drove
    our economy, whether it is steel in Youngstown or agriculture
    around places like Lexington, Ohio, or the Port of Cleveland
    shipping raw materials and finished goods all over the Midwest.
        As an expert on--as an economic historian, as you are, and
    an expert on the Great Depression, you are aware, obviously, of
    the role of manufacturing, especially a historic role, in
    pulling our Nation out of recession.
        As many Ohioans can tell you, can painfully tell you,
    manufacturing steadily declined over the last three decades. At
    the same time, we know that the financial industry has rapidly
    expanded.
        As recently as the 1980s, manufacturing made up 25 percent
    of GDP; financial services made up less than half of that, in
    the vicinity of 11 or 12 percent. Those numbers crossed in the
    1990s. Now it is almost a direct flip. Manufacturing, 12
    percent; financial services, 20 or 21 percent.
        Wall Street's output, put another way, was equal to all the
    Farm Belt States and the Industrial Belt States combined. In
    2004, 44 percent of all corporate profits in the United States
    came from the financial sector compared with 10 percent from
    manufacturing. And I say that as a preface to my question for
    this reason: Kevin Phillips, the writer, has noted sort of the
    history of great nations in the last 400 years. Habsburg Spain,
    the United Provinces of Netherlands, and Imperial England, all
    three saw their economies go from manufacturing, shipping,
    agriculture--depending on which of each of the three--and
    energy into more and more emphasis on financial services. And
    the financialization in that sense is what probably cost those
    empires their empire. They were countries that never really
    recovered in the wealth creation. It really is the fact that
    banking is not an independent source of wealth. It does not
    cause our prosperity. The success of banking is created by our
    success and our ability to create wealth.
        Then I hear people, when I talk about manufacturing policy,
    I hear your predecessors say this, I hear advisers in the White
    House, regardless of party, say we cannot have a manufacturing
    policy, we cannot pick winners and losers. Well, it is pretty
    clear in the 1980s that this country, this Government, your
    predecessors, and the Treasury Department picked winners and
    losers. They decided that financialization, the financial
    services sector should be the winner as we got rid of usury
    laws, as we changed rules and deregulated and all those things.
    So we put ourselves in a position where, as Kevin Phillips
    said, finance is the chosen sector of the U.S. economy.
        So my question is this: As your role, your statutory role,
    a mandated target of 4-percent unemployment, it is at least
    twice, maybe three times that right now. When I look at a
    building on the Oberlin College campus 20 miles from my house,
    fully powered by solar energy, the largest solar-powered
    building on any college campus in America, about 8 years it was
    built. All the panels were built in Germany, a country that had
    an industrial policy that stimulated demand and supply and have
    built clean energy jobs way better than we have. You read the
    articles in the paper about what China is about to way
    outcompete us on alternative energy, solar and wind turbines.
    We know all that. We still sit with no manufacturing policy.
        So my question is this: As the economic historian that you
    are, are you troubled by the fact that the financial sector is
    now twice the size of the manufacturing sector? And I put
    parentheses around the next part of that, that no country that
    I can see in economic history has done well when that happened.
    Are you troubled by that? And if you are troubled by that fact
    that the financial industry is twice the size of manufacturing,
    flipping what it was, what should we do about it and what are
    you doing about it?
        Mr. Bernanke. Well, financial services obviously has a
    place to play in a modern economy, and it is a productive
    industry in the sense that it helps allocate capital more
    effectively and share risk and do important things like that. I
    think we would all agree that over the past decade or so,
    financial services, residential construction, and some other
    sectors may have become too big relative to other sectors, and
    we are now seeing the painful unwinding of that process.
        I think the right way to address the size of financial
    services is to make sure that it is being productive and
    constructive, and that means having a good regulatory regime
    that directs--that provides a context in which financial
    services will do productive, constructive things for the
    economy. So good financial regulatory reform should lead the
    financial services industry to adjust to an appropriate size
    that is right for the economy.
        On manufacturing, it is really a mixed picture in the
    United States. We still are probably the biggest or one of the
    biggest manufacturers in the world. We are the most productive.
    We have had extraordinary increases in productivity, in
    manufacturing recently. That, in fact, is part of the reason
    why the employment share of manufacturing keeps going down, is
    that we need fewer workers to produce a car or an airplane than
    we used to.
        Senator Brown. That is true, Mr. Chairman, but look at the
    profits of the financial services--the chasm between financial
    services and manufacturing is--the chasm is big in terms of the
    percentage of GDP. It is even larger in terms of profits in the
    last 5 years. Keep that in mind.
        Mr. Bernanke. So in terms of the financial industry, you
    know, I think markets should be allowed to work, but they
    should be allowed to work in an environment where regulation is
    appropriate and where there is an appropriate level playing
    field. So you would, I suppose, agree that financial services
    were not appropriately regulated or appropriately supervised.
    If we strengthen that regulation and allow appropriate changes
    to take place, that ought to bring down the size of the
    financial services industry to a size which is more appropriate
    for our economy.
        Manufacturing is another issue. I think there are lots of
    things that mostly Congress--I do not think the Federal Reserve
    has a lot of direct influence on any particular sector. But
    there are a lot of things that Congress can do. There is tax
    policy, there is immigration policy, trade policy.
        There is the issue of picking winners and losers. I think
    that is difficult to do. But you gave the example of solar
    panels. Solar panels are a viable industry with Government
    support if the Congress determines that, for example, for
    global warming purposes that carbon-reducing technologies or
    capital is socially desirable and, therefore, supports that
    activity, then that will--the private sector will, therefore,
    come out and produce that. So that is a determination of
    Congress whether it needs a public subsidy. I do not think that
    many of those alternative energy sources would survive by
    themselves in a marketplace because whatever value they have in
    reducing carbon, for example, is not captured in their price in
    the market.
        So I guess what I am saying is that we need, first of all,
    better regulation in finance to bring finance down to an
    appropriate size and an appropriate set of functions. And there
    are a set of things that Congress can do to try to improve our
    trade balance, for example, to improve the tax policy.
        I think, frankly--and this is a topic that I never could
    get much traction on. I think that our immigration policy which
    restricts severely the number of highly trained, skilled
    immigrants is a problem because bringing those sorts of folks
    in helps our high-tech industries develop more competitive--
    become more competitive. So there are things I think you can do
    to strengthen manufacturing.
        I would also just note that while it has been a very severe
    recession in the manufacturing sector, manufacturing is, in
    fact, leading this recovery, as you pointed out. Industrial
    production has been very strong, and we are seeing, in fact,
    growth in manufacturing employment. So it has been important in
    that respect.
        Senator Brown. One real quick closing statement. If
    manufacturing were even close to the same percentage of GDP as
    it was, think how much stronger--how much quicker we would come
    out of this recession in terms of recovery, just as a point of
    reference perhaps.
        Thank you, Mr. Chairman.
        Senator Johnson. Senator Vitter.
        Senator Vitter. Thank you, Mr. Chairman. Thank you, Mr.
    Chairman, for being here and for your work. Thank you for your
    monetary report.
        Mr. Chairman, when I go around my State and have town hall
    meetings and other things, obviously folks are real concerned
    about jobs and the recession. But I get just as many questions
    and expressions of concern about what they consider the next
    looming crisis caused by spending and debt.
        Now, obviously, you gave us a monetary report focused on
    things you can control. Federal spending and debt is not
    something you can directly control.
        What is your general projection and outlook, once we are
    out of this current recession, for the impact on the current
    levels of what are, in my view, unsustainable Federal spending
    and debt and the impact on the economy?
        Mr. Bernanke. Well, Senator as you point out, at the moment
    we are in a deep recession. Revenues are down to 15 percent of
    GDP. We have a lot of costs arising from the recession, and so
    deficits are extremely high.
        The really interesting question is: What is the structural
    medium-term deficit? If you look at the range of estimates
    provided by the OMB and the CBO over different scenarios and so
    on, most of them suggest that the deficit after we come out of
    recession, say 2013 or so and the rest of that decade, should
    be somewhere between--will be somewhere between 4 and 7 percent
    of GDP.
        That is not a sustainable number. A rule of thumb is that
    in order to keep the ratio of outstanding Government debt to
    our GDP more or less constant--I mean, it would be better even
    to reduce it, but just to keep it constant, you need to have
    deficits more in the area of 2 \1/2\ to 3 percent.
        So I think it is important--so 4 to 7 percent is not
    sustainable. If it were actually to happen, what we would see
    is increasing interest costs, and eventually the markets would
    just entirely lose confidence in our fiscal policy, and
    interest rates would spike.
        So it is very important for Congress--even though we are
    now still in a very deep recession or in a very weak economy,
    it is important for Congress to try to clarify how we are going
    to exit from our fiscal position and try to provide a credible
    blueprint for how our Federal deficit will be controlled over
    the next 10 years and 20 years.
        Senator Vitter. And just to follow up on that, let us say
    in the future we reach a point that we are truly out of this
    recession in a meaningful way and those deficits are where they
    are projected, 4 to 7 percent, versus 2 \1/2\. How quickly
    would that become a major problem in terms of the economy?
        Mr. Bernanke. Well, it could become a problem tomorrow if
    bond markets are not persuaded that Congress is serious about
    bringing down the deficit over time. But in any case, certainly
    if you look at the CBO numbers, you know, by 2025, 2030, under
    existing policies we are going to be seeing the curve very
    sharply rising and----
        Senator Vitter. But surely way before that it would be an
    issue and a problem in terms of interest rates, et cetera.
        Mr. Bernanke. Absolutely. Absolutely. And you would be
    seeing debt-to-GDP ratios rising; you would be seeing crowding
    out of investments and other problems. Yes, absolutely.
        Senator Vitter. So is it fair to say, you know, we are
    perhaps not seeing those immediate threats because we are in a
    serious recession? Once we come out of that, those immediate
    threats, the chances of their having a real negative impact
    elevate enormously.
        Mr. Bernanke. That is right. And we are not completely sure
    we will not have negative effects even sooner than that.
        Senator Vitter. Before that.
        Mr. Bernanke. Depending on how interest rates respond.
        Senator Vitter. Right. Mr. Chairman, I want to Fannie Mae
    and Freddie Mac. On June 18, the Treasury Secretary said before
    us, ``Fannie and Freddie were a core part of what went wrong in
    our system.'' I assume you agree with that.
        Mr. Bernanke. Yes, sir.
        Senator Vitter. We are discussing regulatory reform. In
    terms of the draft bills we are discussing, there is no title
    on Fannie and Freddie. When should we be addressing that?
    Sooner rather than later, or when?
        Mr. Bernanke. Well, I think for no other reason than just
    trying to reduce uncertainty in the markets, the sooner that
    you can come to some clarity on the future of Fannie and
    Freddie, the better. Of course, I understand that you are
    dealing with a lot of complex issues in financial reform and
    health care and in other areas right now. But it would be,
    obviously, helpful to try to get some clarity on that.
        That does not mean necessarily that you can get to that new
    situation quickly. It is going to take some time to move from
    the current situation to a more stable long-run situation. But
    certainly I hope Congress is looking at this issue now and
    thinking about where you want to go.
        Senator Vitter. OK. We are really not looking at the issue
    now, at least in a meaningful way. And the schedule, as I
    understand it, particularly from Treasury, is not until 2011.
    Is there any good reason, in your opinion, to essentially put
    that off to 2011?
        Mr. Bernanke. Well, I think their concern is just that the
    agenda is so full and is there time, you know, for everyone to
    focus on that. And that is not my judgment to make, but I think
    that is their concern. I think they would agree that an earlier
    resolution would be better, certainly.
        Senator Vitter. OK. Mr. Chairman, I want to go to
    resolution authority and 13(3) type authority, and we have
    talked about this before, but it is really important so I want
    to have the discussion quickly again.
        If in our regulatory reform package we come up with a
    reasonable, workable wind-down mechanism to resolve large
    failed institutions in an orderly way, to take them down, to
    break them up in an orderly way, if we do that, would you
    support our also ending, taking away 13(3) and other similar
    authority from the Fed and others to put taxpayer dollars in
    large quantities into individual firms?
        Mr. Bernanke. In short, yes, I would support that--13(3)
    has been used two ways. It has been used in what you would call
    bailouts, and it has been used in developing these broad-based
    lending facilities to help individual markets, like the ones we
    just closed down on February 1st. I think the latter is a
    valuable thing to have in case of a future crisis, but we would
    be happy to give up any involvement in the wind-down of
    failing, systemically critical firms.
        Senator Vitter. And just to make clear, I am talking about
    the former not the latter, so I think we are on the same page.
        Mr. Bernanke. We are on the same page.
        Senator Vitter. As I understand the Treasury's position,
    they say they support a resolution authority, but they
    essentially also want to keep that other authority as ``foam on
    the runway,'' as sort of a backup plan, however you want to
    term it. Do you think that is necessary or a good idea?
        Mr. Bernanke. It depends on exactly how the resolution
    authority is structured. It might be that you want the Fed to
    be available to provide liquidity as part of the resolution
    process, for example. But, generally speaking, I prefer that
    you develop a process that leaves the Fed to do only its
    standard discount window lending against collateral as it
    always has done, without use of the emergency authority.
        Senator Vitter. So if we get the resolution authority
    right, you do not see any need for that other authority with
    regard to individual firms continuing to exist?
        Mr. Bernanke. We would be very happy if you could find a
    solution that allows us to give up that authority.
        Senator Vitter. OK.
        Senator Johnson. Could you gentlemen wrap it up?
        Senator Vitter. OK. I have one more question, which is
    about audits and transparency of the Fed. I welcomed your
    recent written comments about that as certainly movement in the
    right direction from my point of view. One thing you
    underscored was some delay in terms of disclosing certain
    action so as not to disrupt the markets in terms of an
    immediate disclosure of certain activity.
        What is your reaction to the idea of having the same
    disclosure with a lag for all loans and collateral used to
    secure loans made by the Fed--in other words, the normal
    discount window activity?
        Mr. Bernanke. Including the names of the borrowers?
        Senator Vitter. Correct.
        Mr. Bernanke. That is a concern that we have, and the
    problem is that if banks think they are going to be--that their
    names are going to be publicized, then they will not come even
    if they are under attack by the market, even if there is a
    panic or a run on the firm. So it is a very delicate issue. I
    think we will have further discussions, I am sure, but we are
    quite nervous about essentially shutting down the viability of
    this critical tool, which proved to be very valuable during the
    crisis. So that is something that we are concerned about, even,
    you know, with a delay.
        Senator Vitter. So even with a delay.
        Mr. Bernanke. You know, I am sure we will have further
    discussions about this, but, you know, again, if a company is
    under attack by people who do not believe that it is stable and
    they know that if they go to the window, their name is going to
    be published even with some delay, they may feel that they have
    no option, that they will just have to fail, because if they go
    to the window and that is revealed, then the market will then
    believe that they, in fact, are not stable, and the whole
    purpose of the discount window loan will not be served.
        So that is a particularly sensitive one for us, even though
    that is a relatively small part of our lending.
        Senator Vitter. OK. Thank you.
        Senator Johnson. Senator Warner.
        Senator Warner. Thank you, Mr. Chairman. I appreciate
    getting my time.
        Thank you, Chairman Bernanke, for being here. I do share
    one concern that Senator Vitter mentioned about the deficit,
    and, gosh, I wish we would have supported Senator Gregg's
    proposal when we had a chance. I think it was still the best,
    perhaps last best proposal to actually force this Congress to
    take an up-or-down vote on a plan that would put us back into
    fiscal sanity.
        I want to come back on the question of financial
    regulation. Mr. Chairman, you make, I think, a strong case
    about the need to have sophisticated, strong supervision for
    bank holding companies and that this supervision has to take a
    look at not just individual supervision but systemic risk in a
    macro level. I still think we are weighing where that role
    should be, and I am not sure, at least from my standpoint,
    while you make a strong case that you have fully made the case
    that it absolutely has to be deposited within the Federal
    Reserve, that it could perhaps be deposited elsewhere.
        You know, one of the comments you have made--and we are now
    18 months after the crisis, and you have said that you have
    looked at the Fed within supervision of the bank holding
    companies, stronger capital, stronger risk supervision. You
    know, we have had a lot of discussion over the last 18 months
    about size. We have talked a little bit earlier--Senator Reed
    raised questions about the Volcker Rule, and I share some of
    your concerns about how you draw those lines. Chairman Dodd
    raised the question about use of some of the instruments out
    there in terms of derivatives.
        Could you tell us a little bit in this last 18 months, with
    this increased focus on the large sophisticated bank holding
    companies that you currently supervise, you know, what steps
    that has taken to strengthen that supervision in a little more
    specific way than you did in your----
        Mr. Bernanke. Well, it would take me quite a long time.
        Senator Warner. Perhaps you could give that for the record.
    I would like to see----
        Mr. Bernanke. OK. So just very briefly, there has been a
    lot on the regulatory side. We are working with our colleagues
    in Basel and elsewhere to substantially strengthen and
    modernize the capital requirements, liquidity requirements,
    executive compensation requirements, risk management
    requirements, and a whole raft of things just to give a
    tougher, stronger regime. So that is an important part.
        In terms of supervision, we are restructuring our internal
    organization, and we think a landmark event, a watershed event
    was the stress tests last spring, which were incredibly
    successful, which the Federal Reserve led. And I think the
    Federal Reserve's input to that was to supplement the standard
    bank examiner going in looking at the credit file with a lot of
    analytical statistical information which helped improve
    comparability across banks, which helped to determine the
    factors underlying possible risks to banks, which integrated
    the macroscenarios so we could do stress tests and those sorts
    of things.
        So in our internal structure, we are, first of all,
    creating a new group which will bring together not just the
    bank supervisors but people from other dividends--and I
    mentioned the economists, the payment system people, the
    financial people, and so on--to manage the supervisory effort
    for the system as a whole, and they will be looking at a
    portfolio of firms, and so it will not be a firm-by-firm
    operation where this teams looks at Citigroup and this team
    looks at JP Morgan. Instead, they will be looking collectively
    at groups of firms doing horizontal comparisons and taking a
    more systemic type approach.
        On top of that, we will also have a quantitative evaluation
    team which increases something we have already done, which is
    currently for small banks, we do not go in every year or every
    6 months. What we tend to do is we look at a bunch of data, a
    bunch of call report information, for example, and use
    statistical models to try and evaluate whether there are
    problems that we should go back and look.
        Well, expanding that idea in a much more sophisticated way,
    we can give these quantitative folks the license to look at a
    range of activities in the firms and look at them across firms
    and try to use their offsite type analysis to supplement and
    support the on-side analysis.
        Senator Warner. Because I want to be absolutely sensitive
    to my colleagues' times who have been waiting here for a long
    time, I want to just get one more point out.
        Mr. Bernanke. Sure.
        Senator Warner. I have got a lot of other questions, but I
    will take them at another time.
        Specifically in terms of, I believe, within safety and
    soundness you can look at proprietary trading, hedge fund
    activities, and private equity, whether you have ramped up on
    that, and one of the issues that one of the panels raised with
    us a little bit earlier that I thought was quite good was the
    whole question of interconnectedness, and I will close with
    that. But I would love to get your quick comments on that,
    recognizing other folks have been waiting a long time.
        Mr. Bernanke. So we have not tried to apply the Volcker
    rules. We have not forbidden some activities. But we have----
        Senator Warner. Heightened.
        Mr. Bernanke. Yes, we have heightened our activities,
    particularly with respect to risk management. We find that was
    the big Achilles heel in the whole situation, that firms did
    not really have a sufficient understanding of the broad-based
    exposure across all their business lines to certain kinds of
    risks. And we have been working very hard on that part.
        Senator Warner. Interconnectedness.
        Mr. Bernanke. On interconnectedness, this is a place, I
    think, where the Federal Reserve really has a comparative
    advantage. We have, for example, been working very hard on
    strengthening the operations of the credit default swap market,
    the tri-party repo market, et cetera. And in doing that, we are
    looking at how the--it is critical to us--you know, JP Morgan
    plays a critical role in the tri-party repo market. DTCC plays
    a critical role in the securities clearing markets and so on.
        So we are integrating those with our analysis of the firms,
    and that is extremely important. We are paying a lot of
    attention to that.
        Senator Warner. Thank you, Mr. Chairman.
        Senator Johnson. Senator Gregg?
        Senator Gregg. Were you here earlier than I was, Jim?
        Senator Johnson. Senator DeMint?
        Senator Gregg. I think Senator DeMint was here. He left. I
    do believe he is--go ahead.
        Senator DeMint. Thank you, Mr. Chairman.
        Thank you, Mr. Bernanke, for enduring us again here. I
    really appreciate you being here. I apologize for missing some
    of the questions, but I did hear your testimony.
        I would just like to get a broad perspective. I know we are
    talking about a lot of the details of financial monetary
    systems, but just maybe a larger concern. As I look at what we
    are doing here in Washington overall and a lot of the debate
    about specifics, it does seem that the underlying debate is
    more about are we going to have a free market economy or more
    of a centrally planned, government-directed economy. And there
    are very different views on monetary policy depending really on
    what our paradigm is, I believe.
        My concern is as I look at where we are even versus 5 years
    ago, that the Federal Government owns two of our largest auto
    companies, our largest insurance company, our largest mortgage
    company. We are heavy in debate about expanding government
    control of health care. We pretty much control the energy
    sector, where we drill, all of those kinds of things. We are
    considering now a new financial reform package that would
    supercede State control, go all the way down to payday lenders
    and pawn shops. And in the process of moving in this direction,
    we have created huge debts, unsustainable, and 10-year
    projections are more than a trillion dollars a year additional
    debt.
        My concern is that in your testimony, that you didn't
    mention any of this. Not until we questioned the debt was it a
    concern. I mean, I know it is a concern. I am not suggesting it
    is not. But I would think that given the fact that the
    uniqueness of the American economic system has a lot to do with
    more of the Adam Smith invisible hand, bottom up, that the
    Chairman of our Federal Reserve would express some concern
    about the expansion of government ownership and controls of
    large sections of the private sector economy, knowing that
    there is a tipping point at some point where we no longer
    function as a free market economy.
        I am not sure if we have gone past that or not, but my
    concern and alarm is that you had not expressed any concern or
    alarm of the need for Congress to look at ways to devolve and
    divest of these things, to try to move things back in that
    direction. Is that not a concern, or is your focus just not--
    your focus is what you have to do with what you have got to
    work with and that is just not your area?
        Mr. Bernanke. Well, Senator, first, I have, obviously, a
    lot of things to talk about, so I can't cover everything of
    concern.
        Senator DeMint. Sure.
        Mr. Bernanke. Let me talk about the financial sector, and I
    think there, that returning to a more market-oriented financial
    sector is a top priority and we are, in fact, doing that. For
    example, all the big banks have now paid back their TARP money
    and we are trying as quickly as we can to get those banks
    financed by private capital, which they have raised a great
    deal of private capital and it is very important.
        AIG, of course, is very problematic, but they are selling
    off assets in order to pay us back and they are making progress
    on that, and our objective there, of course, is to put them
    back in the private sector.
        We talked earlier about Fannie and Freddie, and I do think
    that we have to get away from this neither fish nor fowl
    situation where they are part public, part private. I think one
    solution would be to privatize those firms, and I think that is
    an interesting direction to go.
        If I might, I think perhaps the most important thing, as a
    number of people have discussed, this Committee is looking at
    too big to fail, looking at resolution authorities and so on.
    If you were able to get a strong resolution authority, you
    would do more to bring back a level competitive playing field,
    market discipline into the financial sector than anything else
    that you can do, because with a true resolution authority where
    creditors know they will lose money, shareholders know they
    will lose money if the firm fails, then they have the incentive
    after that to evaluate the firm's credit, quality, and their
    risk taking and so on, and that would, again, bring back
    competition, bring back market discipline.
        So I am very much in favor of bringing back the market in
    all these areas, recognizing that the financial sector does
    need appropriate regulation, but market forces and competition
    ought to play a substantial role, and I am all in favor of
    doing that and will work with you on that.
        Senator DeMint. Well, I appreciate that and I suspect we
    have very much the same philosophies about economies. But I
    think the country and the world needs to know that and I just
    would appreciate as you look at where we are that there is a
    need to back away from where we are. A lot has happened in a
    short period of time that has expanded the government scope in
    a lot of areas, and there is a big difference in central
    planning concepts, as you know more than I do, than free market
    accountabilities, and I think you are talking about and believe
    in. So I appreciate that and I thank the Chairman for allowing
    me to ask a question. I yield back.
        Senator Johanns. Senator Bayh?
        Senator Bayh. Thank you, Mr. Chairman. It is good to see
    you again.
        First, just a comment. I count myself as one who believes
    the Fed should retain a robust role in the supervisory area.
    The reason for that is that any new entity would have to get up
    to speed. There would be a learning curve there that I think
    would present some difficulties.
        Second, my strong impression is that you and your team have
    learned from the recent past about what can go wrong and that
    can inform your decisionmaking going forward.
        And third, my impression is that you gain some important
    insights by the oversight at the micro level informing your
    judgment about setting monetary policy and making macro
    decisions. So that is kind of my take on how we ought to view
    this going forward.
        Just a couple of questions. First, as you mentioned, the
    last quarter GDP figures were pretty good, but a big chunk of
    that was inventory rebuilding and that sort of thing. So we are
    all worried about the sustainability of the recovery, the risk
    of a double-dip, that sort of thing.
        You mentioned the key to this, to have it become self-
    sustaining, is final private demand. I don't want you to wade
    into the political thickets, but there is a debate in Congress
    about what measures we might take to augment final private
    demand. Do you have any sense about what steps would be prudent
    to take at this time to put some wind at the back of the
    recovery and ensure that it is sustainable?
        Mr. Bernanke. Well, as you know, Senator, I don't like to
    inject myself in debates on fiscal policies----
        Senator Bayh. But as an economist, do you care to offer
    any?
        Mr. Bernanke. Well, no. I don't think I can separate my
    role that easily. My sense is, I mean, just as an observer, it
    seems that the Congress is debating a number of potential
    fiscal actions, but none of them are--I think no one is
    proposing anything of the scale we saw last year, as far as I
    know----
        Senator Bayh. Well, let me put it another way. The Senate
    voted the other day on a $15 billion package. I voted for it.
    There are some good things in there. Some of my colleagues
    disagreed, took a different approach. Just in terms of scale, I
    mean, most people would say, even myself, some good things, I
    voted for it, but that is unlikely to be of a magnitude that is
    going to materially add to final private demand, to use your
    words. Do you have any sense about the scale that would be
    needed to have a material impact on final private demand?
        Mr. Bernanke. Well, if these smaller programs are well
    designed, they can be very beneficial, and so we don't want to
    denigrate those at all. But----
        Senator Bayh. I didn't mean to, and I wasn't asking you
    to----
        Mr. Bernanke. But my sense is----
        Senator Bayh. I am just trying to get a sense of, what can
    we do to try and ensure the economy gets the legs under it that
    it needs?
        Mr. Bernanke. You know, this is going to sound like a
    dodge, but I think that if you are going to do more fiscal
    policy in the near term, it would be very constructive to
    combine that with more attention to the exit strategy 5 years
    down the line, because I think there is a risk that financial
    markets may begin to become concerned about the sustainability
    of U.S. Fiscal policy, and the more you can assure them of
    ultimate----
        Senator Bayh. It is actually not a dodge. It leads to my
    second question. You were asked by Senator Dodd about the use
    of derivatives and the problems they are having in Greece.
    Senator Vitter touched upon the deficit. I would like to raise
    the question of Greece again. At what level--you know, our
    debt-to-GDP ratio is now going to be going up. Some of that is
    unavoidable because of the recession we are experiencing. But
    you are asking us to focus on the intermediate term, which I
    think is exactly right, and that is why I was a strong
    supporter of the Gregg-Conrad Commission and other steps.
        Do you have a sense, at what ratio of debt-to-GDP do we
    begin to approach the tipping point and really run into a risk
    of currency problems, interest rate spikes, the kinds of things
    that Greece is now experiencing? Do you have any judgment about
    that?
        Mr. Bernanke. It is, of course, very hard to know, and we
    are very different from Greece in terms of the type of our
    economy, the size of our economy, the fact that we have our own
    currency and all those sorts of issues.
        Just to give you one number, Ken Rogoff and Carmen
    Reinhart's book about financial crisis has been discussed in
    many quarters, mentioned a 90 percent debt-to-GDP ratio as a
    level at which growth becomes impacted after that. Now, saying
    that, we have got a wide variety of experience among industrial
    countries, ranging up to very high levels in Japan and in other
    countries. But our historic levels, we were down to the 30s in
    terms of debt-to-GDP and I think heading toward a 100 percent
    debt-to-GDP ratio would be very undesirable, particularly given
    the aging of our society and those obligations we are facing
    longer term.
        Senator Bayh. And we are estimated to get up close to,
    what, 65, 70 percent here over the next five to 10 years,
    something like that?
        Mr. Bernanke. Yes.
        Senator Bayh. My last question. My time is about to expire.
    And we also finance our debt. Japan is mostly internal, isn't
    it? We have a lot of external, which makes it a little bit
    different.
        Are you at all concerned about Japan's recent steps to
    constrain demand there? What impact might--their economy is
    obviously growing very robustly. Does that present any risks to
    the global economy, the fact that they are moving in that
    direction?
        Mr. Bernanke. Do you mean China?
        Senator Bayh. I am sorry. I misspoke. China. Yes, I did
    mean China.
        Mr. Bernanke. No, I am not concerned about it. I think they
    have to make appropriate decisions about not overheating their
    economy. They are obviously growing very quickly. From our
    perspective, we would like to see more flexibility in their
    exchange rate as being part of the process for reducing
    overheating risks. But I think it is important that they
    achieve an appropriate balance between very rapid growth and
    the risks of overheating, the risks that their extensive credit
    extension becomes troubled. So, no, I am not particularly
    concerned about that right now.
        Senator Bayh. Thank you for your service, Mr. Chairman.
    Thank you.
        Senator Johnson. Senator Gregg.
        Senator Gregg. Thank you, Mr. Chairman.
        I want to associate myself with Senator Bayh's comments
    relative to your regulatory authority and the range of
    regulatory authority that you should retain. I do think it is
    important that you be a major player in the regulatory
    atmosphere, and I do believe that although there are obviously
    errors that have occurred across the regulatory regimes, that
    yours are no more grievous than anybody else's, and in fact, I
    think in many ways, less grievous.
        To get into this issue, however, which Senator Bayh has
    touched on, Senator Vitter has touched on, which is when is the
    tipping point, you have basically alluded to the fact that it
    may be sooner rather than later if the markets lose confidence
    in us, the international markets especially. And we have had a
    budget presented to us which puts us on a path, as you
    described, of unsustainability because deficits will run at
    five to 7 percent, debt will triple, and the public debt-to-GDP
    will hit 80 percent by 2015, 2016, and we will hit 60 percent
    this year, actually.
        So the question becomes, what do we need as a government to
    do to give the markets confidence that we are actually taking
    some action, real action in trying to control the out-year
    event, not the immediate issue of getting out of this
    recession, but the fact that in the out years, we have an
    unsustainable situation which could lead to a significant
    financial issue for us as a nation and the reduction in our
    lifestyle and the quality of life and the standard of living of
    our children?
        Mr. Bernanke. Well, the earlier question was about the
    debt-to-GDP ratio, which was the tipping point. Another way to
    look at this is what does the trajectory look like? If the
    trajectory is such that you have an unstable dynamic where
    interest payments get larger and larger, that in turn increases
    the deficit, that in turn leads to higher interest payments and
    it explodes, essentially, then that is a situation where
    markets will become very concerned.
        So I think this is as much a political question as an
    economic question. The question is, can the Congress--and I
    recognize these are very, very hard problems. I don't want to
    in any way downplay the difficulty that it is for Congress to
    address these hard problems. But it would be extraordinarily
    helpful if there was persuasive evidence that Congress had the
    political will to achieve over a number of years a
    stabilization of the debt-to-GDP ratio or of the fiscal
    trajectory, and that could be done either through whatever
    mechanisms you choose to undertake or it may be through
    specific plans, or maybe even through actions that you could
    take now that would affect expenditures and deficits in the out
    years.
        Senator Gregg. But something should be done.
        Mr. Bernanke. It would be very--again, the point I would
    like to make is that there really is some--it is not just a
    question of paying today for a benefit tomorrow. There is
    benefit today if, in fact, you can increase the confidence of
    the markets that we will, in fact, address this issue. It gives
    you more scope and probably lower interest rates today.
        Senator Gregg. And arguably, the markets aren't going to
    have that confidence unless there is an event which gives them
    confidence, which means the Congress has to address the gap
    between spending and revenues with the fact that that gap is
    primarily driven by spending, in my view. That is a rhetorical
    question.
        So where are we in the perception of the world relative to
    this country? Does the world have confidence that we can get
    our house back in order, in your opinion?
        Mr. Bernanke. Well, the markets seem to have confidence. I
    mean, we can sell 20- and 30-year debt at relatively low
    interest rates and I think that is a vote of endorsement for
    the long-term ability of this country to respond to these
    challenges. But we have to make good that trust. We have to
    follow through.
        Senator Gregg. And if we look at the issue of how you get
    the money out of the market, you have put $2 trillion,
    basically, into the economy. Is that about right?
        Mr. Bernanke. The Federal Reserve?
        Senator Gregg. Right.
        Mr. Bernanke. Our balance sheet is $2.3 trillion. It was
    $900 billion before we started, so we have expanded our balance
    sheet by about $1.4 trillion.
        Senator Gregg. So you have got to get that money back out
    at some point, right?
        Mr. Bernanke. That is right.
        Senator Gregg. And I notice you listed a few things here
    that you have got as mechanisms. There is one, however, that I
    wasn't that familiar with. I am not familiar with it at all, to
    be honest with you. You said, the Federal Reserve is currently
    refining plans for a term deposit facility that can convert a
    portion of depository institution holdings of reserves balances
    into deposits that are less liquid. Does that mean you are
    basically going to require bigger reserves?
        Mr. Bernanke. No. It means that instead of having reserves
    held at the Federal Reserve only on an overnight basis, we are
    going to offer a slightly higher interest rate so that banks
    will be willing to hold reserves with us for an extended
    period, and that would take those reserves out of the overnight
    money markets and give us more control over the Federal funds
    rate.
        Senator Gregg. So you are not raising the reserves. You are
    just going to say----
        Mr. Bernanke. No----
        Senator Gregg.----you are going to encourage people to put
    more money in because you are going to pay them interest on it.
    That is part of your new authority?
        Mr. Bernanke. That is part of the authority Congress gave
    us, to pay interest on reserves.
        Senator Gregg. OK. Thank you.
        Senator Johanns. Senator Bennet.
        Senator Bennet. Thank you, Mr. Chairman.
        I was going to go in a different direction, but just
    because the last part of this was so useful, I wanted to say we
    just heard the Fed Chairman talk about the political will in
    Congress to be able to address this issue, and I just--it is
    breathtaking to me as somebody new here that 2 weeks ago, we
    had the chance, because of Senator Gregg's leadership and
    Senator Conrad's leadership, to vote for a bipartisan
    commission--that is all it was--to take a look over a period of
    time and give us recommendations for an up or down vote, and we
    didn't have the political will as an institution even to
    support that.
        So I want to thank Senator Gregg for his leadership and I
    hope we will try again, because we need to demonstrate the
    political will that you are talking about if we are not going
    to leave our kids a completely diminished set of opportunities.
    But I will come back to that.
        I wanted to ask you a question a little bit along the lines
    of what Senator Brown was asking, but different. In Colorado,
    if you look at the last period of economic growth in the
    country before we went into this terrible recession, that
    period of economic growth resulted in an $800 decrease in
    median family income in our State. So the economy grew, but
    middle-class family income fell, as it did across the country.
    For our middle-class families, I would argue, we have got two
    recessions that we are trying to recover from, this one and the
    last period of economic growth that didn't drive their income.
        And at the same time, in our State, the cost of health
    insurance over that period went up by 97 percent. The cost of
    higher education went up by 50 percent. So you have got an
    economy that is driving costs of things that are important to
    move families ahead, but income is going down. And my
    understanding is it is the first time our economy has grown in
    our history and median family income went down.
        I just wonder if you have some thoughts about that, because
    it just feels to me like there are some structural things going
    on in our economy that we need to be worried about, we need to
    concern ourselves with.
        Mr. Bernanke. You are correct that median family income
    hasn't kept up with average GDP or productivity, and there are
    a couple of arithmetic----
        Senator Bennet. Let me just say, because you made that
    point earlier, as well, and at the same time, because of the
    increases in productivity you were talking about, it is not
    apparent where the jobs are going to come from to be able to
    help ameliorate the issues that I was just talking about. I
    will stop there. Sorry.
        Mr. Bernanke. So just in terms of the median income, you
    mentioned one factor, which is the higher costs of benefits and
    medical care, those things which have lowered wage growth as
    opposed to total compensation growth. But more importantly is
    the increased inequality. So you can have a growing economy,
    but if there is more going to the top, then the median guy
    could still be coming down and that is an issue, and I have
    given some speeches on this and tried to address this to some
    extent. I mean, it is a very vexed issue.
        The one thing I think everybody agrees about is that income
    inequality is to some extent tied to educational skills and
    equality. We live in a society where technology is advancing,
    where we are competing with other countries that have very
    large pools of unskilled labor, and therefore, as Senator Brown
    was saying, union jobs in manufacturing are no longer a
    normal--or a predominate form of employment. So for all those
    reasons, in order to get more people to enjoy the benefits of
    productivity and higher economic growth, the training, skills,
    education is a critical part of that.
        One of the advantages of the United States in general is
    that we do have a very flexible system. You know a lot about
    education. But besides K to 12, we have community colleges,
    junior colleges, on-the-job training, and all kinds of other
    ways for people to get skills.
        One of the things I would just say to this Committee as you
    think about our unemployment problem, one of the lasting scars
    of this recession is very likely to be a generation of people
    who have been unemployed for a year or 2 years and will find it
    difficult to come back and get a decent job because their loss
    of skills, because they will have to explain why they were out
    of work for 2 years. So that retraining, those aspects are very
    important.
        Senator Bennet. I think I am already out of time, but let
    me just observe that I agree on the importance of education,
    and it is one of the sad facts of the legacy of the last decade
    that in addition to the economic issues we were just talking
    about, we started the decade, as I understand it, roughly first
    in college degrees, and 10 years later, we are roughly 15th in
    the world. So I wouldn't say that our track record there over
    the last 10 years has been particularly good, either, and it
    just is a reminder of the urgency that we face.
        This is working itself out in the daily lives of Americans.
    I think there is enormous anxiety that we are at risk of being
    the first generation of Americans to leave less opportunity to
    our kids and our grandkids. It goes to the deficit and the debt
    issue we were talking about earlier and also these fundamental
    economic issues.
        I appreciate your being here today. Thank you.
        Mr. Bernanke. Thank you.
        Senator Johanns. Senator Bennett.
        Senator Bennett. Thank you very much, Mr. Chairman, and
    Chairman Bernanke, I appreciate your being here.
        Picking up on what Senator Gregg was talking about, simply
    an observation so that everybody understands exactly what we
    are talking about. When we say political will, cut spending,
    two-thirds of the Federal budget is in mandatory spending, and
    that is a combination of the entitlements, Social Security,
    Medicare, Medicaid, farm subsidies, interest on the national
    debt. I am an appropriator. None of those items come before the
    Appropriations Committee. All of them are on autopilot to be
    spent by virtue of commitments that have been made.
        I once had a very wealthy man say to me, ``Explain to me
    why the Federal Government sends me a check every month for,''
    I have forgotten the number, $250 or whatever it is. He says,
    ``I don't need it.'' And I said, but Sam, you are entitled to
    it, and by law, we are going to give it to you whether we have
    got it or not.
        And let us make it very clear that when we are talking
    about spending, we are talking about fiscal policy, these are
    terms we hide behind when we talk to our constituents and give
    speeches about Congress has got to get tough on spending. The
    real fact is that we have got to have the courage to attack the
    most popular programs in American history. We have got to level
    with our constituents and tell them we are talking about the
    programs you value the most and you insist are off limits. If
    the entitlements are off limits for any kind of discussion here
    on fiscal policy, we are going to hit 10 percent of GDP within
    24 months unless we have the courage to deal with. It is 65 to
    67 percent of the budget now. We are on autopilot to see 75
    percent of the budget within 10 years and the other 25 percent
    includes defense. So if you take defense out of the remaining
    25 percent, you have got about 10 percent of the budget that
    you have to get tough on in order to solve this problem.
        All right. I have finished my soapbox, but I think anybody
    who is paying attention to these hearings ought to hear that
    and understand that because that is the reality.
        Let me get to a question relating to the debt. We had our
    experiences, you and I and all the rest of us, a little over a
    year ago with respect to TARP. One of the things you said to us
    at the time, and we banked on as we voted for TARP, was that
    this was not a bailout. This was money that would come back to
    the Treasury, would come back to the Federal Reserve, wherever
    it came from. And, in fact, you were right. The money is coming
    back, has come back. A lot of the major players of TARP have
    paid it back.
        Now, the Treasury is recycling that money. Senator Gregg
    and I have been very firm about we were in the room when the
    conversation was made as to what would happen to that money
    when it came back, and we thought, naively, that we wrote into
    the law the requirement that when it came back, it would be
    used to pay down the national debt. But we have been informed
    by the Treasury lawyers that that is not what we did.
        I would like your reaction. My opinion is, TARP solved its
    problems. TARP did, indeed, avoid a worldwide depression--a
    worldwide collapse. We maybe are in a worldwide depression, but
    TARP did, indeed, avoid a worldwide collapse in that very
    difficult weekend in September when you came here and said, ``I
    have run out of tools,'' a very chilling kind of comment. One
    of my colleagues said, ``I feel like I am in a James Bond
    movie,'' listening to the Chairman of the Federal Reserve say
    we have run out of tools.
        I think TARP worked. My position, and I would like your
    reaction, is that having worked, it is now time to end it so
    that the Treasury does not recycle it and that when the money
    does come back from those people who benefited from TARP, it
    goes to pay down the national debt. I would like your reaction
    to that.
        Mr. Bernanke. Well, first let me just say on the first part
    of your comments that this is why I think it is so very
    difficult to address these deficit problems, because those are
    very popular programs.
        I agree with you that the TARP, unpopular as it is,
    achieved its basic objective of stabilizing the banking system.
    It did not do as much as we would have liked to create more
    credit. It is now coming back. The financial firms--I would put
    aside the autos and the mortgages.
        Senator Bennett. Right.
        Mr. Bernanke. Just talking about the financial firms,
    including AIG, putting them all together it looks like a pretty
    good chance we are going to break even on that, which would be
    a remarkable--in the long run, which would be a remarkable
    achievement.
        You have put me in a very difficult position. I do not know
    how to adjudicate the legal debate. I think basically
    Congress----
        Senator Bennett. Forget the law. Just give me your opinion
    of whether or not you think TARP should be terminated.
        Mr. Bernanke. It boils down--well, I do not think--I think
    Treasury was right not to terminate it unconditionally at this
    point because there is still some risk out there that we may
    have further financial problems. I think it is small. But to
    have some flexibility in case some new crisis were to arise, I
    think at least for a short period, is not unreasonable.
        I am afraid I am going to have to defer to Congress on
    whether or not you think the other programs that are being
    proposed, like support for small business lending and those
    things, are within the spirit of the TARP or good programs in
    themselves. I do not know how to help you on that one.
        Senator Bennett. All right. Well, this Member of Congress
    thinks they are not.
        Thank you, Mr. Chairman.
        Senator Johnson. Senator Merkley.
        Senator Merkley. Thank you very much, Mr. Chair. And thank
    you, Chair Bernanke, for your testimony.
        I first wanted to note that when Senator Vitter asked the
    question on whether there is a need to limit the Fed's ability
    to use Section 13(3) Federal Reserve Act emergency lending
    power funds to support individual firms, I just wanted to note
    that in Chair Dodd's draft that action--that is, emergency
    lending to individual firms--is prohibited. And so a point I
    was asked to put forward and clarify.
        I wanted to turn to the issue of recapitalizing our
    community banks. This is something I hear about back home all
    the time, the challenge of these banks to be able to put out
    new loans given their leverage limitations and their capital
    challenges. And I had supported an effort to recapitalize
    community banks, and the Administration has now put forward a
    very similar plan. I was just wondering if you could give us
    any insights on your perceptions on how the role of community
    banks in supporting lending to small business might be a factor
    in the recovery of our economy.
        Mr. Bernanke. Well, I think it is very important, and I
    guess on the subject of regulation, I guess I would like to
    remind the Committee that the Federal Reserve, although we have
    been very focused on large institutions over the last couple
    years because of the crisis, we also supervise a large number
    of community banks, State member banks, and they provide us
    very important information about the economy. We can learn from
    them what is happening at the grass-roots level, what is
    happening to lending. And, you know, to get to your question,
    that kind of information is very valuable for us as we try to
    understand what is going on in the economy.
        As you point out, the community banks have in many cases,
    when they are able, when they are strong enough, have been able
    to step up and provide lending. They are very important lenders
    to small businesses, for example. And as you say--and this was
    the issue that Senator Bennett was raising--one of the
    proposals that the Treasury has made is to create a fund that
    would capitalize small banks that demonstrate that they can
    increase their lending to small businesses.
        So in the spirit of my previous conversation with Senator
    Bennett, I am not going to endorse or not endorse that
    approach. There are other approaches also for addressing small
    businesses. But I would say that if you go do that, one
    suggestion the Treasury makes, which is to separate it from the
    TARP, maybe to pass it--this would address Senator Bennett's
    question--to pass it separately so that it is not stigmatized
    or otherwise associated with the restrictions with the TARP,
    which increase the chance that that would be a successful
    program. But we certainly do value the small banks for what
    they are able to do, and if we are going to get this economy
    going again and get employment growing again, then small banks,
    small businesses are going to be critical for that.
        Senator Merkley. Thank you very much, and I want to turn to
    another issue, which is that I was meeting with a group of
    Members of Parliament from Canada two nights ago, and when I
    asked them about the economic meltdown and the impact on
    Canada, they smiled and said:

            Well, you know, we kept the risk out of our banking system, and
            now there is a huge economic movement in which we are going
            down, Canadians are going down and buying up the foreclosed
            real estate in the United States.

    And certainly in your role, there is the chance to look at and
    learn how different models interacted around the world. And
    would you just take a second to comment on the Canada
    structure, how they managed risk, whether there are any
    insights for us here in our efforts to provide regulatory
    reform?
        Mr. Bernanke. I will start with one point, which is that
    Canada's monetary policy was very similar to that of the United
    States, and they had very different outcomes. So those who
    blame this on monetary policy should address that issue. I
    think the differences between Canada and the United States had
    to do with their regulatory structure, and there were two
    primary advantages that they had.
        First, they simply had a much more conservative bank
    supervisory structure in terms of what they allowed banks to
    do, in terms of the amount of capital that banks had. You know,
    in the go-go days, they would be considered staid and
    unexciting. But, of course, that turned out to be the right way
    to go, and they are looked at as models around the world as we
    look at banks supervision.
        The other thing that they did, which we did not avoid, was
    they avoided the deterioration in underwriting standards in
    mortgages and the proliferation of very low downpayments and
    bad underwriting and other problems that came back to bite us
    in the crisis.
        So they took a very conservative approach, and it really
    paid off for them, although given that they are the biggest
    trading partner of the United States, they still have had a
    significant recession, of course.
        Senator Merkley. Well, if I can follow up on your point
    about the underwriting standards, some have argued that the
    reason that Canada proceeded to maintain solid underwriting
    standards was that they had an independent consumer financial
    protection agency and that that vision of defending consumers
    from tricks and traps in lending was never subverted, if you
    will, to other goals, be they safety and soundness, monetary
    policy, and so forth. Any insights on the role that institution
    plays in Canada?
        Mr. Bernanke. I do not know the facts on that, but I would
    agree with you that it is very important to have strong
    consumer protection laws.
        Senator Merkley. I think I am over my time now, so I will
    stop there. But thank you very much.
        Senator Reed. [Presiding.] Senator Shelby, a second round.
        Senator Shelby. Thank you, Mr. Chairman.
        Chairman Bernanke, the Chinese have made a number of
    comments about their massive U.S. Treasury holdings. Last year,
    they publicly ``worried'' about whether their investments were
    safe. Recently, they have expressed the belief that they should
    respond to some of the Obama Administration decisions by
    selling billions of Treasury holdings.
        While China does not have a financial interest in rapidly--
    I do not believe they do--dumping its U.S. dollar assets, it
    may have other competing political interests.
        Do you believe that there is a risk to stability of the
    financial system associated with risk to the value of the
    dollar stemming or coming from international relations between
    China and the United States?
        Second, do you believe that China's large dollar reserve
    holdings pose a threat to the stability of the global financial
    system given the leverage those holdings provide to China to
    enable it to pursue a policy of pegging its currency at an
    artificially low value?
        I know that is a mouthful, but I think these are important
    questions.
        Mr. Bernanke. Well, let me try to address that. First is
    just the factual question. I do not think there has been any
    significant change in China's holding of dollar reserves.
        Senator Shelby. OK.
        Mr. Bernanke. They have continued to acquire reserves. They
    have done that when the dollar was falling. They did that when
    the dollar was rising.
        Senator Shelby. Do you think that is a good thing, a bad
    thing, or are you indifferent about it?
        Mr. Bernanke. I think it arises from a couple of problems.
        Senator Shelby. OK.
        Mr. Bernanke. One problem is their foreign exchange policy
    to keep the currency pegged, and in order to do that, they have
    no alternative but to buy treasuries. The other reason is the
    global imbalances, the fact that they run this very large--
    which is related, of course, to foreign exchange policy, which
    is that they run a very large current account surplus while we
    run a current account deficit. And it was one of the objectives
    discussed by the G-20 leaders in the recent financial summits
    that we should all work to try to get a more balanced trade and
    capital flow situation. So I think it would be a healthier
    situation if China saved less and we saved more and as a result
    they were not accumulating dollar assets so quickly and we had
    a more balanced financial picture.
        I do think that those large capital flows and the potential
    instability of those flows can be a risk to our financial
    system, and, you know, I think we need to try to get those
    imbalances rectified.
        Senator Shelby. Picking up--and it has already been
    mentioned a couple of times by Senator Vitter and others--about
    the GSEs, at this point, as has been said here, there is no
    indication that any GSE reform will take place in the near
    term. In fact, just yesterday Secretary Geithner indicated and
    I think you alluded to this--that the Administration is
    unlikely to provide a plan for reforming these institutions
    prior to 2011 at the earliest.
        I know it is difficult and I know it is costly, but while
    implementing reform will take time, could you describe to the
    Committee here some of the risks that we face should we not
    start the process of reform as soon as possible? In other
    words, if we kick the can down the road, we could cause
    difficult problems, could we not?
        Mr. Bernanke. Yes, sir. First of all, I think you and I
    have a lot in common on this particular issue.
        Senator Shelby. We have worked together on it.
        Mr. Bernanke. We have worked together on it. The Federal
    Reserve has had concerns for a long time, and you were a
    supporter of very good, strong regulatory oversight of Fannie
    and Freddie. And unfortunately, you know, we know how it turned
    out, that they did not have enough capital.
        You know, I think the current situation is worrisome. It
    obviously is a costly situation. And it also generates a
    certain amount of uncertainty in markets as people try to
    anticipate, you know, what the U.S. housing financial situation
    is going to be in the future. Housing policy is a very big part
    of our financial policy in this country, and the lack of
    clarity about that is an issue.
        Now, again, let me just say I sympathize with Secretary
    Geithner in that there is an awful lot going on and financial
    reform is complex. But I do hope we will be thinking about
    where we want to take Fannie and Freddie soon so that we can at
    least provide some clarity to the markets and to the public
    about, you know, where we think this ought to be.
        Senator Shelby. Thank you, Mr. Chairman.
        Senator Reed. Senator Menendez.
        Senator Menendez. Thank you, Mr. Chairman.
        Chairman Bernanke, welcome and congratulations on your
    confirmation.
        Mr. Bernanke. Thank you.
        Senator Menendez. I was pleased to support you.
        Let me ask you, over the next few years, there is going to
    be more than $1 trillion in short-term commercial real estate
    loans that will reach maturity, and the ongoing credit crunch
    will make it very difficult for owners of viable commercial
    real estate to secure long-term financing.
        In 2007, at this Committee hearing with others, I said we
    were going to have a tsunami of foreclosures in the housing
    market. I was told that was an exaggeration. I wish they had
    been right and I had been wrong. And I see this as the next
    looming crisis.
        You know, it seems to me that the Federal Government failed
    to act on the warning signs about the home foreclosure crisis,
    and I am very concerned that we are not acting on increasingly
    clear warning signs about this commercial mortgage market.
        So I am wondering, first, do you believe that this is a
    very serious issue facing us down the road and might this
    emerge as our next economic crisis? And regardless of how you
    might characterize it, which I will wait to hear what you have
    to say, what do you think we can do?
        For example, I have been told that this is one in which
    community banks will face a fair challenge across the spectrum.
    Is, for example, allowing those banks to amortize losses over
    10 years an option so that we do not completely dry up lending
    and at the same time maybe have a lot of these institutions
    close as a result of it?
        I am looking to get ahead of the curve, but that curve is
    coming--that tidal wave is coming really soon, and so I would
    like to hear your views on it.
        Mr. Bernanke. Senator, I share your concerns about this.
    This is yet another place where the Federal Reserve's oversight
    of small and regional banks has been very informative for us.
    We have been able to follow the situation closely and to look
    at its implications for the broader economy and for the
    financial system.
        It seems likely that small and regional banks will be
    facing a lot of challenges from losses on commercial real
    estate, and the bank regulators are watching this very
    carefully because it is going to put a lot of pressure on some
    banks. Chairman Bair, I think the other day, put out a list of
    problem banks, which has been obviously increased, and one of
    the key reasons for that is the commercial real estate issues
    that a lot of small banks are facing. It has the implication
    not only of putting pressure on the banks, but if a small bank
    has lost capital because of its losses in commercial real
    estate, then it does not have the funds to make loans to small
    businesses, for example, so it can permeate, it can affect the
    broader economy as well.
        Just a few comments. As I said, we are very alert to this.
    We are concerned about it. We and the other bank regulators
    have tried to address it. We have put out commercial real
    estate guidance to the banks which attempts to address the
    question you raised about how to deal with debts that are
    coming due. And that guidance, one of the main purposes is,
    first of all, to avoid unnecessary writedowns. So one of the
    guidances we give is that a commercial real state project that
    is able to make the payments but whose collateral value has
    declined should not necessarily be written down for that
    purpose, for example.
        Our guidance also gives specific examples and helps banks
    see how they can restructure loans, just like we restructure
    residential mortgages, in ways that will keep the loan current
    without having a major writedown for the bank. So we have been
    doing that; as bank regulators, we have been trying to find
    solution.
        I also want to mention the TALF again, which is still open
    for commercial mortgage-backed securities. We have had a bit of
    success in bringing down commercial mortgage-backed security
    spreads and in starting up some activity, including activity
    outside of the Fed in creating new CMBS securities. So we are
    very focused on those issues, and we have addressed it in a
    number of different ways.
        I want to end with just a little bit of--I would not say
    good news, but lately the evidence on commercial real estate is
    that there seems to be some improvement in some places, that
    the fundamentals are a little better than we had feared in some
    cases as the economy has done a bit better. And as we said, we
    have seen some more progress in the CMBS market and in banks'
    ability to restructure loans.
        I do not disagree with your initial characterization that
    this is a very, very serious problem that we have to continue
    to monitor, but I would put forward just a sliver of optimism
    recently in terms of some improvement in the outlook for that
    category.
        Senator Menendez. If I may briefly follow up, Mr. Chairman?
    Chairman, I appreciate your answer, and I appreciate the
    guidance that the regulators have given. That is somewhat
    helpful. I am just concerned--and I am happy to hear that there
    is a sliver of a silver lining here about some improvement in
    certain sectors.
        But my sense is that that is not going to meet the
    challenge before us, and I hope that we are thinking
    prospectively about what else we need to do or be ready to do,
    because it seems to me that if the worst-case scenario
    happens--and I have to be honest with you. I have heard from a
    wide sector of community banks, and I have heard from a wide
    sector of those who are in the commercial real estate market,
    who tell me that there is not a market out there for the
    renewal of these mortgages. And as such, it could be a body
    blow to this economy at a time that we are seeing recovery take
    place. And that would be hugely unfortunate as well as
    consequential in a very real way to our overall economy.
        So I would love to continue to engage with you on figuring
    out how we are going to continue from all different levels--not
    just the Federal Reserve, but we have also talked to the
    Treasury about this. We need to figure out how do we best meet
    this challenge, because it is a challenge that is coming. And
    while, you know, those who maybe were irresponsible beyond a
    certain degree will have to face the possibility of closure,
    the breadth and scope of this is something that I am afraid of
    the consequences of what it means to our overall economy.
        Mr. Bernanke. Thank you. We are very focused on it and we
    would like to work with you on it.
        Senator Menendez. All right. Thank you, Mr. Chairman.
        Senator Reed. Senator Bennett?
        Senator Bennett. Thank you, Mr. Chairman.
        The one thing that I hear most often and I think my
    colleagues hear most often as they talk about where we are
    right now, a constant, constant complaint that banks aren't
    lending. And when I talk to the banks, they say, well, we are
    better than we were. Year over year, we are better in 2010 than
    we were in 2009, so the volume has gone up and we are doing our
    best, but we can't find creditworthy borrowers. We are ready to
    loan, but we can't find creditworthy borrowers.
        And then when I drill down a little more, I find the real
    challenge comes from regulators who come in with a definition
    of creditworthy borrowers that say to the bank, OK, you used to
    make auto loans at this number on your credit report and now,
    if that isn't this higher number, you can't make the auto
    loans. I have had business people with whom I have been
    involved personally, now divested myself, say we go to our bank
    with whom we have had a 30-year relationship, say we want to
    make this acquisition, and can we get a loan to fund it, and
    instead of saying yes, as the bank has always said before, we
    like your business plan, we like your track record, you are
    solid people, you know exactly what you are doing, they say, we
    will give you this loan if you can demonstrate that you can pay
    out of your current cash stream. Well, if I could pay out of my
    current cash stream, I wouldn't be coming for the loan to try
    to make the acquisition. And so additional jobs or additional
    productivity that would come from what we would normally think
    of as very ordinary kind of transactions is simply not there.
        And inevitably, it always comes back to the regulators
    won't let us do this. The regulators have tightened their
    requirements of what is considered creditworthy.
        You are the primary regulator. You see this, I am sure,
    every day, or at least your staff does. I would like your
    reaction to that because that is what I hear after the rhetoric
    is all over and the screaming is all over in a political way.
    That is what I hear from the business people. The banks are not
    supporting true entrepreneurial activity in this country, and
    until they do, we won't get the jobs back, we won't get the
    economic recovery going, and they are saying it is primarily
    because of tightened standards on the part of the regulators.
        Mr. Bernanke. Well, it is a difficult problem and one we
    are very focused on, as well. First of all, there is a
    tradeoff. Probably credit terms were too easy before the
    crisis. They have tightened up some. Lately, banks seem to have
    leveled out. They are not tightening any further, at least. But
    there is a tradeoff between making sure that you are really
    making good loans versus making sure that creditworthy
    borrowers are not denied.
        Now, our focus at the Federal Reserve has been to achieve
    an appropriate balance. We want to make sure that creditworthy
    borrowers who are creditworthy can obtain credit, and we have
    been very aggressive in trying to do that. We started with,
    again, these guidances, but these are instructions to our
    examiners as well as to the banks which say, first of all, that
    we strongly encourage banks to make creditworthy loans because
    it is good for the bank, it is good for the borrower, it is
    good for the economy. We have trained our examiners to take
    that approach.
        We have most recently put out yet another guidance on small
    business which actually says, you know, you should not be
    denying credit based on what business you are in, whether you
    are restaurant or whatever, or what geographic location you are
    in. Again, this issue about your collateral value. If that has
    declined, that should not be a reason not to make the loan. We
    are encouraging so-called Second Look Committees who look,
    again, at loans that have been turned down just to make sure
    that there is not a way to make that loan.
        So our guidances, our regulatory philosophy, our training
    of our examiners has been very focused on getting that
    appropriate balance.
        Now, I have said this in previous testimonies. People say,
    well, I am not convinced. What is your evidence? So since then,
    we have been really trying to do outreach and try to get
    information directly back from banks, small businesses. We
    have, for example, put questions in the NFIB's Survey of Small
    Businesses to get more information about their credit
    experience. We are requiring banks to provide us more
    information on small business loans. We have a series of
    meetings and programs at the Reserve Banks which bring together
    small banks, small businesses, community development
    organizations, and so on.
        We are doing our best to go out there and find out what is
    really happening, because in some cases, I mean, I think you
    would agree, in some cases, the regulator is a good scapegoat
    and----
        Senator Bennett. Yes. I understand that.
        Mr. Bernanke.----and gets the credit for the problem. But
    the Federal Reserve, because we have interest, of course, in
    safety and soundness, but we also have interest in a healthy
    economy, and that insight that we get and that balance is very
    important. I realize it doesn't filter down to every bank and
    every situation, but we are making enormous efforts to get that
    balance.
        When you do talk to your business acquaintances, first, ask
    them who the regulator is who is causing the problem, because
    it is not always the Federal Reserve----
        Senator Bennett. I think that is fair.
        Mr. Bernanke. But if you are hearing stories related to the
    Federal Reserve, I would be more than happy to talk to you
    about it and hear more details.
        Senator Bennett. Well, if I could just quickly, Mr.
    Chairman, one other aspect of this that I have discovered as I
    have talked to the people in the venture capital community,
    they say, we are not in the venture capital business anymore.
    To the degree we are investing any money, we are doubling down
    on previous bets, because the pattern used to be the venture
    capital would come in, fund the startup. Once the startup
    proved its viability, it would then go to a bank and get the
    money that it needed to get to the point where it could then
    make an IPO and go public.
        And, they said, we are now discovering that the start-ups
    that we funded in that first wave can't get the bank funding,
    so to keep the organization alive and protect our first
    investment, we double-down on our bet and we are now in a
    position we have never, ever been in before. We are providing
    what the banks used to provide, and as a consequence, there is
    no VC money available for new start-ups and new activities.
        So I am delighted to hear your focus on this. I think you
    are exactly right with the kinds of things you need to do and I
    simply encourage you to keep doing it.
        Mr. Bernanke. We are hearing the same things on venture
    capital that you are hearing.
        Senator Bennett. Thank you, Mr. Chairman.
        Senator Reed. Thank you, Senator Bennett.
        Mr. Chairman, again, thank you for your testimony and for
    your leadership. You, in response to several questions, pointed
    out how central the housing sector is to our economy, and one
    of the areas of great concern to all of us is the mortgage
    foreclosure situation. Frankly, we have not effectively
    responded to that yet. It is a growing phenomenon. In my State,
    one out of ten homes are either in foreclosure or 90-days
    delinquent, and that saps not only the energy from the economy,
    but with the uncertainty in the employment market, with the
    fear of losing your home, particularly for people at mid-life,
    their sense of the American dream is evaporating. Part of what
    we have to do is not only get the economy right, we have to get
    the confidence of the American people restored, and their
    trust.
        So specifically, I am wondering what you can do as the
    Federal Reserve to compel institutions to do more to modify
    mortgages. I get complaints constantly, I am sure my colleagues
    do, that there is a help line number. You call it and, oh, yes,
    sure, and then we don't get back to it. I know there are a lot
    of press releases about everything that is being done, but
    until I think you make it clear that this is an important
    objective, we will get a lot of motion and not a lot of
    results.
        And I would assume, for example, I would hope that as
    within your powers of supervising the management could insist
    that at least there is a calculation done for each mortgage,
    whether a refinancing would be better than a foreclosure, or
    something like that which would be an open process, a quick
    process, and encourage institutions that you regulate--if you
    can't order them, then encourage them, and you have many tools
    to encourage them--to do more.
        Mr. Bernanke. We are doing so. I guess I would first
    mention that our mortgage-backed security purchases----
        Senator Reed. Yes.
        Mr. Bernanke.----lowered the mortgage rate and allowed for
    some millions of refinances, which I am sure has been helpful.
    As you know, the leadership in terms of actual programs is the
    Treasury's program, the HAMP program, and there are a few
    others, the Help for Homeowners and those, and we felt that our
    best way of contributing is to be supportive of those things
    and to strongly encourage both banks and, in our case, as
    consolidated supervisors, we also have supervisory
    responsibilities for non-bank subsidiaries, whether it is some
    servicers or mortgage companies or whatever, to participate and
    to be effective in those programs.
        And we have for some time now been both looking for
    solutions to barriers, legal or accounting barriers, and we
    have been doing research to try to support these programs. For
    example, we have long felt that the problem of being
    underwater, the principal issue, is a serious one, and so that
    was why we were supportive of some of these efforts, like the
    Hope for Homeowners, that involves a principal reduction.
    Unfortunately, that program apparently has not been successful
    in bringing in a lot of participation, but we continue to look
    at different approaches to get restructuring.
        I think it is encouraging. The Treasury, I know, is not
    only trying to do their best to ramp up the HAMP program, and I
    think we will see more permanent modifications coming in since
    they have a pretty big pipeline at this point, but they are
    also doing some pilot programs that involve alternative
    approaches.
        For example, one problem that their approach doesn't deal
    with is the problem of somebody who is unemployed, can't even
    make a reduced payment. So what is needed there is not a
    permanent modification but some temporary assistance. Another
    issue has to do with principal reduction. So in some of their
    pilot programs, I think they are looking to try to take some of
    these different approaches.
        We have worked with them, our economists worked with their
    economists, and we have been very engaged in trying to figure
    out what is the best approach. It is a very hard problem.
    Unfortunately, many foreclosures are just hard to avoid for a
    wide variety of reasons. But where there is a preventable
    foreclosure, it is not only in the interest of the borrower,
    but in the interest of the bank and of the whole economy to try
    to avoid it.
        Senator Reed. I will concede, it is a difficult problem,
    but sometimes you have got to send a very strong message. For
    example, you know, could you set a goal, maybe institution by
    institution of modifications as a condition to access your
    credit facilities? These institutions are borrowing money at
    virtually zero percent and then they are turning around saying,
    we can't modify a loan because of the interest, or we will do,
    from 8 percent, we will cut it 50 basis points, when
    essentially many of these people, when they pay their taxes,
    they are giving them zero percent loans.
        Mr. Bernanke. Well, I don't think we have to use that
    threat. I think we could use our supervisory authority, and we
    went back--in November of 2008, we made very clear in our
    guidance that we expected full compliance and full cooperation
    on this issue and we have had many conversations with the banks
    and----
        Senator Reed. Expecting it and getting it are two different
    things, and I think we have reached the point we have got to
    get it, Mr. Chairman. I know you agree conceptually, but we
    have just got to move on this issue. Senator Menendez sort of
    previewed another potential problem with commercial, but we are
    in the midst of this great residential and it goes right to the
    core of economic confidence and ultimately consumer demand and
    everything else that we have to do.
        Let me switch quickly, and you have been very kind to take
    these questions, but at this juncture and going forward, are
    you using multiple tests for the adequate capital of
    institutions and the adequate sort of resources, i.e.,
    leverage, indexes, liquidity measures, tangible capital as well
    as risk-based capital, or are you still essentially and
    formally simply relying upon the Basel capital requirements?
        Mr. Bernanke. No, we have gone beyond that. We have a
    general principle that there are regulatory minima and then
    above that, you know, we reserve the right to push banks to do
    more, depending on the risks they take and so on. So to give
    two examples, one, we have actually worked with international
    colleagues to develop new liquidity principles. That was one of
    the, I think, real big shortcomings that was made evident in
    the crisis, that they didn't have enough liquidity, and we have
    pushed banks to expand their liquidity and we have been pretty
    successful in doing that.
        The other example I would give is that another thing that
    was illustrated by the crisis was that a lot of the capital,
    quote-unquote, was not really very high quality. It wasn't of
    much use when the crisis came. And so, for example, as we have
    worked with banks in the stress tests or as we work with banks
    who want to repay TARP, we have put very heavy emphasis on
    raising new common equity as the highest quality form of
    capital.
        So yes, and every bank is required to do an internal
    capital assessment that we work with them on to make sure that
    not only are they meeting all the regulatory minima, but they
    are prepared for serious stresses that might come down the
    road.
        Senator Reed. Can I presume that you would not object to
    statutory language requiring multiple tests that are readily
    made and disclosed?
        Mr. Bernanke. Well, I would like to talk to you about
    exactly what those tests would be. We already have capital and
    leverage requirements----
        Senator Reed. No, I would presume they would be the
    measures which you would agree and your colleagues would agree
    were appropriate, but they would not be simply one standard.
    Again, I think some of the problems with the Basel II,
    particularly, were the ability to rely exclusively on credit
    ratings for securitized products, many of which the banks were
    sort of structuring and then buying because they couldn't sell
    them, but they were AAA-rated, so that was a very low charge on
    their risk-based capital but inherently very, very risky, as we
    found out, so----
        Mr. Bernanke. We have been working on the charges and they
    have been substantially increased. We are currently testing out
    the implications of that.
        On the particular issue of these off-balance sheet
    vehicles, as you know, the new accounting standards will force
    banks to consolidate most of those onto their own balance sheet
    and so they will have to have a full capital charge against
    them.
        Senator Reed. And one final question, Mr. Chairman, and
    that is we have talked a lot about derivatives. We all do
    recognize there is a long-term value to derivatives. My
    recollection is the Chicago Board in 1848 started trading
    agricultural futures. In fact, I think I recall a story where
    General Grant and General Sherman showed up to congratulate one
    of the architects for helping them win the Civil War because of
    being able to guarantee supply. So that is the question of the
    utility in that sense, and other senses, is not at stake here.
        But there also is the growing perception, and I am coming
    to a conviction, that many times these devices are used to
    avoid regulatory constraints. In the case of Greece, it might
    have been strictly legal, but clearly the intent was to avoid
    the budget limitations and the budget restrictions of joining
    the European Community.
        With respect to many other derivatives, for example, even
    commercial derivatives, because they are not typically recorded
    as lending, or in some cases not even on the books, it is
    borrowing that is not in violation of covenance with other
    lenders. It is borrowing that allows additional leverage. And
    one of the problems we are trying to recognize now is over-
    leverage.
        So to the extent that we have to deal with these
    derivatives, any thoughts our guidance about how we prevent
    them from being used not for economic hedging but for clearly
    and very deliberately--maybe legally, maybe not--avoiding your
    capital requirements, the lending covenants of a bank, and many
    other examples.
        Mr. Bernanke. Yes. There are two related issues here. One
    has to do with circumventing accounting rules, which maybe is
    what Greece is about. After Enron, that turned out to be--a lot
    of financial arrangements essentially were structured to avoid
    accounting requirements and we, at that time, the Federal
    Reserve--not me personally, but the Federal Reserve--came down
    pretty hard, providing sets of rules and guidances to banks to
    assure that they were not creating special structures or in
    order to----
        Senator Reed. And yet they did.
        Mr. Bernanke.----in order to avoid accounting rules. The
    Greek thing is from before that period, as far as we know.
        Senator Reed. Yes.
        Mr. Bernanke. We are looking into that, but as far as we
    know, that was about 10 years ago that those were done. So that
    is one set of issues.
        The other set of issues has to do with whether hedging,
    which is in principle a good thing, is actually true hedging or
    not, and the poster child for that would be the capital hedges
    that banks took out with AIG which allowed them to reduce their
    capital standards because they were, quote, protected by the
    credit default swaps with AIG. And there, the challenge is to
    make sure that when the hedge takes place, that it is a true
    hedge and that it doesn't induce other risks, like counterparty
    risks, for example, or liquidity risks.
        So it is a difficult technical problem, but you are
    absolutely right that derivatives have a legitimate role for
    hedging risks, but if they are used to distort accounting
    results or regulatory ratios, then that needs to be addressed.
    We are working on that as part of the broad reforms that Basel
    is undertaking.
        Senator Reed. Thank you very much, Mr. Chairman.
        Mr. Bernanke. Thank you.
        Senator Reed. Seeing no other members, the hearing is
    adjourned.
        Mr. Bernanke. Thank you.
        [Whereupon, at 11:49 a.m., the hearing was adjourned.]
        [Prepared statements and responses to written questions
    supplied for the record follow:]

                     PREPARED STATEMENT OF BEN S. BERNANKE
           Chairman, Board of Governors of the Federal Reserve System
                               February 25, 2010

        Chairman Dodd, Ranking Member Shelby, and other members of the
    Committee, I am pleased to present the Federal Reserve's semiannual
    Monetary Policy Report to the Congress. I will begin today with some
    comments on the outlook for the economy and for monetary policy, then
    touch briefly on several other important issues.
    The Economic Outlook
        Although the recession officially began more than 2 years ago, U.S.
    economic activity contracted particularly sharply following the
    intensification of the global financial crisis in the fall of 2008.
    Concerted efforts by the Federal Reserve, the Treasury Department, and
    other U.S. authorities to stabilize the financial system, together with
    highly stimulative monetary and fiscal policies, helped arrest the
    decline and are supporting a nascent economic recovery. Indeed, the
    U.S. economy expanded at about a 4 percent annual rate during the
    second half of last year. A significant portion of that growth,
    however, can be attributed to the progress firms made in working down
    unwanted inventories of unsold goods, which left them more willing to
    increase production. As the impetus provided by the inventory cycle is
    temporary, and as the fiscal support for economic growth likely will
    diminish later this year, a sustained recovery will depend on continued
    growth in private-sector final demand for goods and services.
        Private final demand does seem to be growing at a moderate pace,
    buoyed in part by a general improvement in financial conditions. In
    particular, consumer spending has recently picked up, reflecting gains
    in real disposable income and household wealth and tentative signs of
    stabilization in the labor market. Business investment in equipment and
    software has risen significantly. And international trade--supported by
    a recovery in the economies of many of our trading partners--is
    rebounding from its deep contraction of a year ago. However, starts of
    single-family homes, which rose noticeably this past spring, have
    recently been roughly flat, and commercial construction is declining
    sharply, reflecting poor fundamentals and continued difficulty in
    obtaining financing.
        The job market has been hit especially hard by the recession, as
    employers reacted to sharp sales declines and concerns about credit
    availability by deeply cutting their workforces in late 2008 and in
    2009. Some recent indicators suggest the deterioration in the labor
    market is abating: Job losses have slowed considerably, and the number
    of full-time jobs in manufacturing rose modestly in January. Initial
    claims for unemployment insurance have continued to trend lower, and
    the temporary services industry, often considered a bellwether for the
    employment outlook, has been expanding steadily since October.
    Notwithstanding these positive signs, the job market remains quite
    weak, with the unemployment rate near 10 percent and job openings
    scarce. Of particular concern, because of its long-term implications
    for workers' skills and wages, is the increasing incidence of long-term
    unemployment; indeed, more than 40 percent of the unemployed have been
    out of work 6 months or more, nearly double the share of a year ago.
        Increases in energy prices resulted in a pickup in consumer price
    inflation in the second half of last year, but oil prices have
    flattened out over recent months, and most indicators suggest that
    inflation likely will be subdued for some time. Slack in labor and
    product markets has reduced wage and price pressures in most markets,
    and sharp increases in productivity have further reduced producers'
    unit labor costs. The cost of shelter, which receives a heavy weight in
    consumer price indexes, is rising very slowly, reflecting high vacancy
    rates. In addition, according to most measures, longer-term inflation
    expectations have remained relatively stable.
        The improvement in financial markets that began last spring
    continues. Conditions in short-term funding markets have returned to
    near pre-crisis levels. Many (mostly larger) firms have been able to
    issue corporate bonds or new equity and do not seem to be hampered by a
    lack of credit. In contrast, bank lending continues to contract,
    reflecting both tightened lending standards and weak demand for credit
    amid uncertain economic prospects.
        In conjunction with the January meeting of the Federal Open Market
    Committee (FOMC), Board members and Reserve Bank presidents prepared
    projections for economic growth, unemployment, and inflation for the
    years 2010 through 2012 and over the longer run. The contours of these
    forecasts are broadly similar to those I reported to the Congress last
    July. FOMC participants continue to anticipate a moderate pace of
    economic recovery, with economic growth of roughly 3 to 3 \1/2\ percent
    in 2010 and 3 \1/2\ to 4 \1/2\ percent in 2011. Consistent with
    moderate economic growth, participants expect the unemployment rate to
    decline only slowly, to a range of roughly 6 \1/2\ to 7 \1/2\ percent
    by the end of 2012, still well above their estimate of the long-run
    sustainable rate of about 5 percent. Inflation is expected to remain
    subdued, with consumer prices rising at rates between 1 and 2 percent
    in 2010 through 2012. In the longer term, inflation is expected to be
    between 1 \3/4\ and 2 percent, the range that most FOMC participants
    judge to be consistent with the Federal Reserve's dual mandate of price
    stability and maximum employment.

    Monetary Policy
        Over the past year, the Federal Reserve has employed a wide array
    of tools to promote economic recovery and preserve price stability. The
    target for the Federal funds rate has been maintained at a historically
    low range of 0 to \1/4\ percent since December 2008. The FOMC continues
    to anticipate that economic conditions--including low rates of resource
    utilization, subdued inflation trends, and stable inflation
    expectations--are likely to warrant exceptionally low levels of the
    Federal funds rate for an extended period.
        To provide support to mortgage lending and housing markets and to
    improve overall conditions in private credit markets, the Federal
    Reserve is in the process of purchasing $1.25 trillion of agency
    mortgage-backed securities and about $175 billion of agency debt. We
    have been gradually slowing the pace of these purchases in order to
    promote a smooth transition in markets and anticipate that these
    transactions will be completed by the end of March. The FOMC will
    continue to evaluate its purchases of securities in light of the
    evolving economic outlook and conditions in financial markets.
        In response to the substantial improvements in the functioning of
    most financial markets, the Federal Reserve is winding down the special
    liquidity facilities it created during the crisis. On February 1, a
    number of these facilities, including credit facilities for primary
    dealers, lending programs intended to help stabilize money market
    mutual funds and the commercial paper market, and temporary liquidity
    swap lines with foreign central banks, were allowed to expire.\1\ The
    only remaining lending program for multiple borrowers created under the
    Federal Reserve's emergency authorities, the Term Asset-Backed
    Securities Loan Facility, is scheduled to close on March 31 for loans
    backed by all types of collateral except newly issued commercial
    mortgage-backed securities (CMBS) and on June 30 for loans backed by
    newly issued CMBS.
    ---------------------------------------------------------------------------
        \1\ Primary dealers are broker-dealers that act as counterparties
    to the Federal Reserve Bank of New York in its conduct of open market
    operations.
    ---------------------------------------------------------------------------
        In addition to closing its special facilities, the Federal Reserve
    is normalizing its lending to commercial banks through the discount
    window. The final auction of discount-window funds to depositories
    through the Term Auction Facility, which was created in the early
    stages of the crisis to improve the liquidity of the banking system,
    will occur on March 8. Last week we announced that the maximum term of
    discount window loans, which was increased to as much as 90 days during
    the crisis, would be returned to overnight for most banks, as it was
    before the crisis erupted in August 2007. To discourage banks from
    relying on the discount window rather than private funding markets for
    short-term credit, last week we also increased the discount rate by 25
    basis points, raising the spread between the discount rate and the top
    of the target range for the Federal funds rate to 50 basis points.
    These changes, like the closure of most of the special lending
    facilities earlier this month, are in response to the improved
    functioning of financial markets, which has reduced the need for
    extraordinary assistance from the Federal Reserve. These adjustments
    are not expected to lead to tighter financial conditions for households
    and businesses and should not be interpreted as signaling any change in
    the outlook for monetary policy, which remains about the same as it was
    at the time of the January meeting of the FOMC.
        Although the Federal funds rate is likely to remain exceptionally
    low for an extended period, as the expansion matures, the Federal
    Reserve will at some point need to begin to tighten monetary conditions
    to prevent the development of inflationary pressures. Notwithstanding
    the substantial increase in the size of its balance sheet associated
    with its purchases of Treasury and agency securities, we are confident
    that we have the tools we need to firm the stance of monetary policy at
    the appropriate time.\2\
    ---------------------------------------------------------------------------
        \2\ For further details on these tools and the Federal Reserve's
    exit strategy, see Ben S. Bernanke (2010), ``Federal Reserve's Exit
    Strategy,'' statement before the Committee on Financial Services, U.S.
    House of Representatives, February 10, www.federalreserve.gov/
    newsevents/testimony/bernanke20100210a.htm.
    ---------------------------------------------------------------------------
        Most importantly, in October 2008 the Congress gave statutory
    authority to the Federal Reserve to pay interest on banks' holdings of
    reserve balances at Federal Reserve Banks. By increasing the interest
    rate on reserves, the Federal Reserve will be able to put significant
    upward pressure on all short-term interest rates. Actual and
    prospective increases in short-term interest rates will be reflected in
    turn in longer-term interest rates and in financial conditions more
    generally.
        The Federal Reserve has also been developing a number of additional
    tools to reduce the large quantity of reserves held by the banking
    system, which will improve the Federal Reserve's control of financial
    conditions by leading to a tighter relationship between the interest
    rate paid on reserves and other short-term interest rates. Notably, our
    operational capacity for conducting reverse repurchase agreements, a
    tool that the Federal Reserve has historically used to absorb reserves
    from the banking system, is being expanded so that such transactions
    can be used to absorb large quantities of reserves.\3\ The Federal
    Reserve is also currently refining plans for a term deposit facility
    that could convert a portion of depository institutions' holdings of
    reserve balances into deposits that are less liquid and could not be
    used to meet reserve requirements.\4\ In addition, the FOMC has the
    option of redeeming or selling securities as a means of reducing
    outstanding bank reserves and applying monetary restraint. Of course,
    the sequencing of steps and the combination of tools that the Federal
    Reserve uses as it exits from its currently very accommodative policy
    stance will depend on economic and financial developments. I provided
    more discussion of these options and possible sequencing in a recent
    testimony.\5\
    ---------------------------------------------------------------------------
        \3\ The Federal Reserve has recently developed the ability to
    engage in reverse repurchase agreements in the triparty market for
    repurchase agreements, with primary dealers as counterparties and using
    Treasury and agency debt securities as collateral, and it is developing
    the capacity to carry out these transactions with a wider set of
    counterparties (such as money market mutual funds and the mortgage-
    related government-sponsored enterprises) and using agency mortgage-
    backed securities as collateral.
        \4\ In December the Federal Reserve published a proposal describing
    a term deposit facility in the Federal Register (see Board of Governors
    of the Federal Reserve System (2009), ``Federal Reserve Board Proposes
    Amendments to Regulation D That Would Enable the Establishment of a
    Term Deposit Facility,'' press release, December 28,
    www.federalreserve.gov/newsevents/press/monetary/20091228a.htm) We are
    now in the process of analyzing the public comments that have been
    received. A revised proposal will be reviewed by the Federal Reserve
    Board, and test transactions could commence during the second quarter.
        \5\ See Bernanke, ``Federal Reserve's Exit Strategy,'' in note 2.
    ---------------------------------------------------------------------------
    Federal Reserve Transparency
        The Federal Reserve is committed to ensuring that the Congress and
    the public have all the information needed to understand our decisions
    and to be assured of the integrity of our operations. Indeed, on
    matters related to the conduct of monetary policy, the Federal Reserve
    is already one of the most transparent central banks in the world,
    providing detailed records and explanations of its decisions. Over the
    past year, the Federal Reserve also took a number of steps to enhance
    the transparency of its special credit and liquidity facilities,
    including the provision of regular, extensive reports to the Congress
    and the public; and we have worked closely with the Government
    Accountability Office (GAO), the Office of the Special Inspector
    General for the Troubled Asset Relief Program, the Congress, and
    private-sector auditors on a range of matters relating to these
    facilities.
        While the emergency credit and liquidity facilities were important
    tools for implementing monetary policy during the crisis, we understand
    that the unusual nature of those facilities creates a special
    obligation to assure the Congress and the public of the integrity of
    their operation. Accordingly, we would welcome a review by the GAO of
    the Federal Reserve's management of all facilities created under
    emergency authorities.\6\ In particular, we would support legislation
    authorizing the GAO to audit the operational integrity, collateral
    policies, use of third-party contractors, accounting, financial
    reporting, and internal controls of these special credit and liquidity
    facilities. The Federal Reserve will, of course, cooperate fully and
    actively in all reviews. We are also prepared to support legislation
    that would require the release of the identities of the firms that
    participated in each special facility after an appropriate delay. It is
    important that the release occur after a lag that is sufficiently long
    that investors will not view an institution's use of one of the
    facilities as a possible indication of ongoing financial problems,
    thereby undermining market confidence in the institution or
    discouraging use of any future facility that might become necessary to
    protect the U.S. economy. An appropriate delay would also allow firms
    adequate time to inform investors through annual reports and other
    public documents of their use of Federal Reserve facilities.
    ---------------------------------------------------------------------------
        \6\ Last month the Federal Reserve said that it would welcome a
    full review by the GAO of all aspects of the Federal Reserve's
    involvement in the extension of credit to the American International
    Group, Inc. (see Ben S. Bernanke (2010), letter to Gene L. Dodaro,
    January 19, www.federalreserve.gov/monetarypolicy/files/
    letter_aig_20100119.pdf). The Federal Reserve would support legislation
    authorizing a review by the GAO of the Federal Reserve's operations of
    its facilities created under emergency authorities: the Asset-Backed
    Commercial Paper Money Market Mutual Fund Liquidity Facility, the
    Commercial Paper Funding Facility, the Money Market Investor Funding
    Facility, the Primary Dealer Credit Facility, the Term Asset-Backed
    Securities Loan Facility, and the Term Securities Lending Facility.
    ---------------------------------------------------------------------------
        Looking ahead, we will continue to work with the Congress in
    identifying approaches for enhancing the Federal Reserve's transparency
    that are consistent with our statutory objectives of fostering maximum
    employment and price stability. In particular, it is vital that the
    conduct of monetary policy continue to be insulated from short-term
    political pressures so that the FOMC can make policy decisions in the
    longer-term economic interests of the American people. Moreover, the
    confidentiality of discount window lending to individual depository
    institutions must be maintained so that the Federal Reserve continues
    to have effective ways to provide liquidity to depository institutions
    under circumstances where other sources of funding are not available.
    The Federal Reserve's ability to inject liquidity into the financial
    system is critical for preserving financial stability and for
    supporting depositories' key role in meeting the ongoing credit needs
    of firms and households.

    Regulatory Reform
        Strengthening our financial regulatory system is essential for the
    long-term economic stability of the nation. Among the lessons of the
    crisis are the crucial importance of macroprudential regulation--that
    is, regulation and supervision aimed at addressing risks to the
    financial system as a whole--and the need for effective consolidated
    supervision of every financial institution that is so large or
    interconnected that its failure could threaten the functioning of the
    entire financial system.
        The Federal Reserve strongly supports the Congress's ongoing
    efforts to achieve comprehensive financial reform. In the meantime, to
    strengthen the Federal Reserve's oversight of banking organizations, we
    have been conducting an intensive self-examination of our regulatory
    and supervisory responsibilities and have been actively implementing
    improvements. For example, the Federal Reserve has been playing a key
    role in international efforts to toughen capital and liquidity
    requirements for financial institutions, particularly systemically
    critical firms, and we have been taking the lead in ensuring that
    compensation structures at banking organizations provide appropriate
    incentives without encouraging excessive risk-taking.\7\
    ---------------------------------------------------------------------------
        \7\ For further information, see Board of Governors of the Federal
    Reserve System (2009), ``Federal Reserve Issues Proposed Guidance on
    Incentive Compensation,'' press release, October 22,
    www.federalreserve.gov/newsevents/press/bcreg/20091022a.htm.
    ---------------------------------------------------------------------------
        The Federal Reserve is also making fundamental changes in its
    supervision of large, complex bank holding companies, both to improve
    the effectiveness of consolidated supervision and to incorporate a
    macroprudential perspective that goes beyond the traditional focus on
    safety and soundness of individual institutions. We are overhauling our
    supervisory framework and procedures to improve coordination within our
    own supervisory staff and with other supervisory agencies and to
    facilitate more-integrated assessments of risks within each holding
    company and across groups of companies.
        Last spring the Federal Reserve led the successful Supervisory
    Capital Assessment Program, popularly known as the bank stress tests.
    An important lesson of that program was that combining onsite bank
    examinations with a suite of quantitative and analytical tools can
    greatly improve comparability of the results and better identify
    potential risks. In that spirit, the Federal Reserve is also in the
    process of developing an enhanced quantitative surveillance program for
    large bank holding companies. Supervisory information will be combined
    with firm-level, market-based indicators and aggregate economic data to
    provide a more complete picture of the risks facing these institutions
    and the broader financial system. Making use of the Federal Reserve's
    unparalleled breadth of expertise, this program will apply a
    multidisciplinary approach that involves economists, specialists in
    particular financial markets, payments systems experts, and other
    professionals, as well as bank supervisors.
        The recent crisis has also underscored the extent to which direct
    involvement in the oversight of banks and bank holding companies
    contributes to the Federal Reserve's effectiveness in carrying out its
    responsibilities as a central bank, including the making of monetary
    policy and the management of the discount window. Most important, as
    the crisis has once again demonstrated, the Federal Reserve's ability
    to identify and address diverse and hard-to-predict threats to
    financial stability depends critically on the information, expertise,
    and powers that it has by virtue of being both a bank supervisor and a
    central bank.
        The Federal Reserve continues to demonstrate its commitment to
    strengthening consumer protections in the financial services arena.
    Since the time of the previous Monetary Policy Report in July, the
    Federal Reserve has proposed a comprehensive overhaul of the
    regulations governing consumer mortgage transactions, and we are
    collaborating with the Department of Housing and Urban Development to
    assess how we might further increase transparency in the mortgage
    process.\8\ We have issued rules implementing enhanced consumer
    protections for credit card accounts and private student loans as well
    as new rules to ensure that consumers have meaningful opportunities to
    avoid overdraft fees.\9\ In addition, the Federal Reserve has
    implemented an expanded consumer compliance supervision program for
    nonbank subsidiaries of bank holding companies and foreign banking
    organizations.\10\
    ---------------------------------------------------------------------------
        \8\ For further information, see Board of Governors of the Federal
    Reserve System (2009), ``Federal Reserve Proposes Significant Changes
    to Regulation Z (Truth in Lending) Intended to Improve the Disclosures
    Consumers Receive in Connection with Closed-End Mortgages and Home-
    Equity Lines of Credit,'' press release, July 23,
    www.federalreserve.gov/newsevents/press/bcreg/20090723a.htm.
        \9\ For more information, see Board of Governors of the Federal
    Reserve System (2009), ``Federal Reserve Approves Final Amendments to
    Regulation Z That Revise Disclosure Requirements for Private Education
    Loans,'' press release, July 30, www.federalreserve.gov/newsevents/
    press/bcreg/20090730a.htm; Board of Governors of the Federal Reserve
    System (2009), ``Federal Reserve Announces Final Rules Prohibiting
    Institutions from Charging Fees for Overdrafts on ATM and One-Time
    Debit Card Transactions,'' press release, November 12,
    www.federalreserve.gov/newsevents/press/bcreg/20091112a.htm; and Board
    of Governors of the Federal Reserve System (2010), ``Federal Reserve
    Approves Final Rules to Protect Credit Card Users from a Number of
    Costly Practices,'' press release, January 12, www.federalreserve.gov/
    newsevents/press/bcreg/20100112a.htm.
        \10\ For further information, see Board of Governors of the Federal
    Reserve System (2009), ``Federal Reserve to Implement Consumer
    Compliance Supervision Program of Nonbank Subsidiaries of Bank Holding
    Companies and Foreign Banking Organizations,'' press release, September
    15, www.federalreserve.gov/newsevents/press/bcreg/20090915a.htm.
    ---------------------------------------------------------------------------
        More generally, the Federal Reserve is committed to doing all that
    can be done to ensure that our economy is never again devastated by a
    financial collapse. We look forward to working with the Congress to
    develop effective and comprehensive reform of the financial regulatory
    framework.

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

    Emergency Lending Under Section 13(3)
    Q.1.a. Charles Plosser, President of the Federal Reserve Bank
    of Philadelphia, stated in a recent speech his belief that the
    Fed's emergency 13(3) lending authority should be either
    eliminated or severely curtailed (``The Federal Reserve System:
    Balancing Independence and Accountability,'' presented February
    17, 2010 by President Plosser to the World Affairs Council of
    Philadelphia). He stated:

            I believe that the Fed's 13(3) lending authority should be
            either eliminated or severely curtailed. Such lending should be
            done by the fiscal authorities only in emergencies and, if the
            Fed is involved, only upon the written request of the Treasury.
            Any non-Treasury securities or collateral acquired by the Fed
            under such lending should be promptly swapped for Treasury
            securities so that it is clear that the responsibility and
            accountability for such lending rests explicitly with the
            fiscal authorities, not the Federal Reserve. To codify this
            arrangement, I believe we should establish a new Fed-Treasury
            Accord. This would eliminate the ability of the Fed to engage
            in `bailouts' of individual firms or sectors and place such
            responsibility with the Treasury and Congress, squarely where
            it belongs.

    Do you agree with President Plosser?

    A.1.a Since the fall of 2008, I have advocated that Congress
    establish a statutory resolution regime that provides a
    workable alternative to Government bailouts and disorderly
    bankruptcies. With enactment of a workable resolution regime
    for systemically important firms, I have also called for
    removal of the Federal Reserve's authority under section 13(3)
    to extend credit to troubled nonbanking entities.
        However, I believe that it would be appropriate for the
    Federal Reserve to retain the authority to lend to establish
    broad market-based credit facilities in unusual and exigent
    circumstances. In exceptional circumstances the preservation of
    financial stability may require that the Federal Reserve have
    the authority to provide liquidity to restart or encourage
    markets to operate, thereby providing liquidity needed to allow
    households, small businesses, depositors and others access to
    working liquid markets. The need for such authority was fully
    evident during the financial crisis, when preventing a
    financial catastrophe required that the Federal Reserve provide
    liquidity to money market mutual funds, primary dealers, the
    commercial paper market, and the market for student loans,
    credit card loans, small business loans and the commercial real
    estate market.

    Q.1.b. Do you believe that modifications to Section 13(3) of
    the Federal Reserve Act would be useful in clarifying emergency
    responses of various branches of government to financial
    crises? If so, what modifications do you believe would be most
    useful?

    A.1.b. Apart from a possible elimination of the authority to
    lend to single firms (as discussed above), I do not believe
    that significant modifications to section 13(3) are necessary
    or appropriate. The Federal Reserve has historically been
    extremely cautious in using the section 13(3) authority.
        Prior to the recent financial crisis, the Federal Reserve
    had authorized the extension of credit under section 13(3) in
    only one circumstance since the Great Depression and had not in
    fact extended credit under this section since the 1930s.
        During this financial crisis, the Federal Reserve worked
    closely with the Department of the Treasury before exercising
    authority under section 13(3). We believe this consultation is
    important and appropriate and would not object to a statutory
    provision requiring consultation with or approval by the
    Secretary of the Treasury prior to authorizing an extension of
    credit under section 13(3).

    Q.1.c. Do you favor the establishment of a new Fed-Treasury
    Accord to provide greater distinction between fiscal policy
    actions and lender-of-last resort actions taken by the Federal
    Reserve in an emergency?

    A.1.c. The Federal Reserve and the Treasury have an accord that
    sets forth the principles applied by each in addressing the
    current crisis. We would favor a legislative provision allowing
    the Federal Reserve to transfer to the Treasury obligations
    that, while acquired in the course of Federal Reserve action as
    the lender of last resort, become fiscal obligations more
    appropriately managed by the Treasury Department. We would be
    happy to work with you on developing this type of approach.
    Interest on Reserves
    Q.2. Congress provided the authority to pay interest on
    reserves to the Board of Governors of the Federal Reserve, and
    not the Federal Open Market Committee (FOMC). Similarly, the
    Board of Governors, and not the FOMC, has authority over
    setting the discount rate and reserve requirements. According
    to minutes of the January 26-27, 2010, FOMC meeting, the
    interest rate paid on excess reserve balances (the IOER rate)
    is one of the tools available to support a gradual return to a
    more normal monetary policy stance. Quoting from the minutes:

            Participants expressed a range of views about the tools and
            strategy for removing policy accommodation when that step
            becomes appropriate. All agreed that raising the IOER rate and
            the target for the Federal funds rate would be a key element of
            a move to less accommodative monetary policy.

       LAre there any possible future conflicts or
            difficulties that you could imagine might arise from
            having the Federal Reserve's target for the Federal
            funds rate determined by the FOMC while the IOER and
            discount rate are determined by the Board of Governors?

       LAs it moves toward a more normal monetary policy
            stance, the Federal Reserve may use the IOER rate to
            help manage reserve balances. If the IOER rate, rather
            than a target for a market rate, becomes an indicator
            of the stance of monetary policy for a time, will the
            balance of power over monetary policy between the FOMC
            and the Federal Reserve Board change?

    A.2. As you know, the Congress has assigned to the Board the
    responsibility for determining the rate paid on reserves.
    Although the Federal Open Market Committee (FOMC) by law is
    responsible for directing open market operations, the Congress
    has also assigned to the Board the responsibility for
    determining certain other important terms that are relevant for
    the conduct of monetary policy--for example, the Board
    ``reviews and determines'' the discount rates that are
    established by the Federal Reserve Banks; the Federal Open
    Market Committee has no statutory role in setting the discount
    rate. Similarly, the Board sets reserve requirements subject to
    the constraints established by the Congress; the Federal Open
    Market Committee has no statutory role in setting reserve
    requirements.
        For many years, the Board and the FOMC have worked
    collegially and cooperatively in setting the discount rate, the
    Federal funds target rate, and other instruments of monetary
    policy. I am convinced that the Board and the FOMC will
    continue to work cooperatively in the future in adjusting all
    of the instruments of monetary policy.
    Monetary Policy and Fiscal Policy Distinction
    Q.3.a. Several regional Federal Reserve bank presidents have
    expressed concern that actions taken by the Fed, many under
    Section 13(3) authority, were actions to channel credit to
    specific firms or specific segments of financial markets and
    the economy. The concern is that some actions amounted to
    fiscal, and not lender of last resort, policies. Moreover, in a
    March 23, 2009 joint press release, the Fed and the Treasury
    stated the following:

            The Federal Reserve to avoid credit risk and credit allocation

            The Federal Reserve's lender-of-last-resort responsibilities
            involve lending against collateral, secured to the satisfaction
            of the responsible Federal Reserve Bank. Actions taken by the
            Federal Reserve should also aim to improve financial or credit
            conditions broadly, not to allocate credit to narrowly defined
            sectors or classes of borrowers. Government decisions to
            influence the allocation of credit are the province of the
            fiscal authorities.

        In accord with the joint statement, should the Fed's stock
    of agency debt and mortgage-backed securities along with its
    Maiden Lane holdings be swapped for Treasury securities,
    thereby transparently placing the channeling of credit support
    to the housing sector firmly in the hands of fiscal
    authorities?

    A.3.a. The Federal Reserve's purchases of agency debt and
    mortgage-backed securities, and the credit it has extended to
    the Maiden Lane entities, arose for different reasons and
    deserve different treatment.
        The primary purpose of the Federal Reserve's purchases of
    securities issued or guaranteed by Federal agencies was a
    monetary policy response intended to support the overall
    economy by providing support to the mortgage and housing
    sectors. The Federal Reserve believes that in routine
    circumstances the modes of government support for the housing
    sector should be determined by the Congress and carried out
    through agencies other than the Federal Reserve.
        For that reason, the Federal Reserve in recent decades
    minimized its participation in the agency securities markets.
    However, the highly strained financial market conditions of the
    past few years prevented the Federal Reserve's monetary policy
    actions to lower interest rates from being fully transmitted to
    housing markets, as would have happened in more normal times,
    and the Federal Reserve's ability to lower short-term interest
    rates further was constrained after short-term rates were
    lowered to essentially zero. In the circumstances, the Federal
    Reserve initiated a program to purchase agency debt and
    mortgage-backed securities.
        The credit extensions to AIG and the Maiden Lane entities
    represent exercise of the Federal Reserve's authority as lender
    of last resort. The Treasury Department is better suited to
    make the policy and management decisions that attend the longer
    term relationship with a nonbanking firm that requires
    government assistance. Accordingly, the Federal Reserve would
    support a transfer to the Treasury of its AIG and Maiden Lane
    credits. The issues regarding a possible swap of agency debt
    and MBS securities for Treasury securities are somewhat more
    complex and would require careful study.

    Q.3.b. The Fed has purchased over $1 trillion of agency
    mortgage-backed-securities and intends to complete purchases of
    $1.25 trillion of those securities by the end of March. To help
    finance those purchases, the Fed uses supplemental borrowing
    from the Treasury and issues interest-bearing reserve balances.
    In effect, the Fed is borrowing from the public, including
    banks, with promises to repay the borrowed sums plus interest.
    The Fed will continue that borrowing in order to hold on to its
    mortgage-backed securities until those assets gradually decline
    as they mature or are prepaid or sold. When the Fed effectively
    finances an enormous portfolio holding of a specific class of
    assets using interest bearing debt issued to the public, how is
    that not a fiscal policy exercise?

    A.3.b. Monetary policy and fiscal policy are different tools
    that both can be used to stimulate the economy. The purpose of
    the Federal Reserve's large-scale asset purchases was primarily
    to apply macroeconomic stimulus by lowering longer-term
    interest rates and by improving financial market functioning;
    fiscal policy applies stimulus by adjusting overall government
    spending or revenues. Because the Federal Reserve's large-scale
    asset purchases involved changes in the central bank's balance
    sheet--and, in particular, the creation of a large volume of
    reserves, it is clear that the purchases were a monetary policy
    action. Moreover, the Federal Reserve's decision to purchase a
    large volume of longer-term assets in the crisis was consistent
    with its statutory mandate to promote maximum employment and
    price stability, and it was clearly supported by its statutory
    authorities. These transactions can and will be unwound in a
    manner consistent with these same mandates.
    Systemic Risk Regulation
    Q.4.a. Your February 25, 2010, testimony identifies that the
    Fed is making fundamental changes in its supervision of bank
    holding companies to, in your words, ``incorporate a
    macroprudential perspective that goes beyond the traditional
    focus on safety and soundness of individual institutions.''
        Could you precisely define what you mean by a
    ``macroprudential perspective,'' and what metrics guide that
    perspective?

    A.4.a. Our supervisory approach should better reflect our
    mission, as a central bank, to promote financial stability. As
    was evident in the financial crisis, complex, global financial
    firms can be profoundly interconnected in ways that can
    threaten the viability of individual firms, the functioning of
    key financial markets, and the stability of the broader
    economy. A macroprudential perspective requires a more system-
    wide approach to the supervision of systemically critical firms
    that considers the interdependencies among firms and markets
    that have the potential to undermine the stability of the
    financial system. To that end, we have supported the creation
    of a council of regulators that would gather information from
    across the financial system, identify and assess potential
    risks to the financial system, and work with member agencies to
    address those risks.
        In our own supervisory efforts, we are reorienting our
    approach to some of the largest holding companies to better
    anticipate and mitigate systemic risks. For example, we expect
    to increase the use of horizontal reviews, which focus on
    particular risks or activities across a group of banking
    organizations. In doing so, we have drawn on our experience
    with the Supervisory Capital Assessment Program (SCAP), in
    which the Federal Reserve led a coordinated effort by the bank
    supervisors to evaluate on a consistent basis the capital needs
    of the largest banking institutions in an adverse economic
    scenario. Because the SCAP involved the simultaneous evaluation
    of potential credit exposures across all of the included firms,
    we were better able to consider the systemic implications of
    financial stress under an adverse economic scenario, in
    addition to the impact of an adverse scenario on individual
    firms.
        The SCAP also showed the benefits of drawing on the work of
    a wide range of staff--including supervisors, economists, and
    market and payments system experts--to comprehensively evaluate
    the risks facing financial firms. Going forward, the Federal
    Reserve is instituting a data-driven, quantitative surveillance
    mechanism that will draw on a similar range of staff expertise
    to provide an independent view of the risks facing large
    banking firms. As part of that effort, we are developing
    quantitative tools to help identify vulnerabilities at both the
    firm level and for the aggregate financial sector. We
    anticipate that these tools will incorporate macroeconomic
    forecasts, including spillover and feedback effects. We also
    expect to develop indicators of interconnectedness, which could
    encompass common credit, market, and funding exposures. The
    development of specific metrics will also depend, in part, on
    the availability of timely and comparable data from
    systemically important firms.

    Q.4.b. Does the Fed intend to redefine what regulators should
    regard as ``safety and soundness?''

    A.4.b. Ensuring the safety and soundness of institutions has
    been a cornerstone of the Federal Reserve's supervision
    program. The recent crisis has shown that large, interconnected
    firms can be buffeted by a market-driven crisis, magnifying
    weaknesses in risk management practices, and revealing capital
    and liquidity buffers calibrated to withstand institution-
    specific stress events to be insufficient. For this reason,
    leading supervisors in the United States and abroad are
    reviewing the prudential standards needed to ensure safety and
    soundness for individual firms and the financial system as a
    whole. 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.
        We are working with our domestic and international
    counterparts to develop capital and prudential requirements
    that take account of the systemic importance of large, complex
    firms whose failure would pose a significant threat to overall
    financial stability. Options under consideration include
    assessing a capital surcharge on these institutions or
    requiring that a greater share of their capital be in the form
    of common equity. For additional protection, systemically
    important institutions could be required to issue contingent
    capital, such as debt-like securities that convert to common
    equity in times of macroeconomic stress or when losses erode
    the institution's capital base. U.S. supervisory agencies have
    already increased capital requirements for trading activities
    and securitization exposures, two of the areas in which losses
    were especially high.
        Liquidity requirements should also be strengthened for
    systemically critical firms, as even solvent financial
    institutions can be brought down by liquidity problems. The
    bank regulatory agencies are implementing strengthened guidance
    on liquidity risk management and weighing proposals for
    quantitatively based requirements. In addition to insufficient
    capital and inadequate liquidity risk management, flawed
    compensation practices at financial institutions also
    contributed to the crisis. Compensation should appropriately
    link pay to performance and provide sound incentives. The
    Federal Reserve has issued proposed guidance that would require
    banking organizations to review their compensation practices to
    ensure they do not encourage excessive risk-taking, are subject
    to effective controls and risk management, and are supported by
    strong corporate governance including board-level oversight.
    Federal Reserve's Asset Holdings
    Q.5. Charles Plosser, President of the Federal Reserve Bank of
    Philadelphia, stated in a recent speech that

            . . . the Fed could help preserve its independence by limiting
            the scope of its ability to engage in activities that blur the
            boundary lines between monetary and fiscal policy. Thus, as the
            economic recovery gains strength and monetary policy begins to
            normalize, I would favor our beginning to sell some of the
            agency mortgage-backed securities from our portfolio rather
            than relying only on redemptions of these assets. Doing so
            would help extricate the Fed from the realm of fiscal policy
            and housing finance.

    Do you agree with President Plosser?

    A.5. I provided my views on asset sales in my March 25, 2010,
    testimony before the House Committee on Financial Services. The
    relevant passage is reproduced below.
        When these tools [reverse repurchase agreements and term
    deposits] are used to drain reserves from the banking system,
    they do so by replacing bank reserves with other liabilities;
    the asset side and the overall of the Federal Reserve's balance
    sheet remain unchanged. If necessary, as a means of applying
    monetary restraint, the Federal Reserve also has the option of
    redeeming or selling securities. The redemption or sale of
    securities would have the effect of reducing the size of the
    Federal Reserve's balance sheet as well as further reducing the
    quantity of reserves in the banking system. Restoring the size
    and composition of the balance sheet to a more normal
    configuration is a longer-term objective of our policies. In
    any case, the sequencing of steps and the combination of tools
    that the Federal Reserve uses as it exits from its currently
    very accommodative policy stance will depend on economic and
    financial developments and on our best judgments about how to
    meet the Federal Reserve's dual mandate of maximum employment
    and price stability.
    Treasury Financing Account at the Fed
    Q.6. On February 23, 2010, the Treasury announced, rather
    suddenly and surprisingly, and without much explanation, that
    it anticipates increasing its Supplementary Financing Account
    at the Fed by around $200 billion over the next 2 months. This
    means, essentially, that the Treasury will borrow on behalf of
    the Fed and simply hold the funds in the Treasury's account at
    the Fed. I understand that the Treasury's Supplementary
    Financing Program helps the Fed absorb reserves from the
    banking system and manage its balance sheet. I wonder, however,
    about the lack of information concerning why the Treasury
    suddenly decided to increase its balance at the Fed.
       LWas the Treasury's February 23 announcement planned
            in advance and coordinated with the Fed, or was it a
            surprise to the Fed?

       LWhat are the future plans for the size of the
            Treasury's Supplemental Financing Account?

       LWho will decide what will be the future balances in
            the Supplemental Financing Account?

    A.6. The Treasury and the Federal Reserve consulted closely on
    the Treasury's February 23 announcement regarding the
    Supplementary Financing Program. However, the Treasury makes
    all decisions on balances to be held in the Supplementary
    Financing Account.
    Efforts to Toughen Capital and Liquidity Requirements
    Q.7.a. Your testimony on February 25, 2010 identifies that

             . . . the Federal Reserve has been playing a key international
            role in international efforts to toughen capital and liquidity
            requirements for financial institutions, particularly
            systemically critical firms . . .

    Could you describe what those efforts have been?

    A.7.a. The Federal Reserve has an active leadership role within
    the Finance Stability Board, the Basel Committee for Banking
    Supervision, and various other international supervisory fora.
    Through these fora, especially the Basel Committee, the Federal
    Reserve has worked diligently with supervisors from around the
    world to develop a comprehensive series of reforms to address
    the lessons that we have learned from the recent global
    financial crisis. The goal of the Basel Committee's reform
    package is to improve the international banking sector's
    ability to deal with future economic and financial stress, thus
    reducing the contagion risk from the financial sector to the
    real economy.
        The Federal Reserve co-chairs three Basel Committee working
    groups that are focusing on reforms especially pertinent to
    systemically important institutions. These groups are
    developing: a) revisions to the capital regulations for trading
    book activities, designed to enhance risk measurement and to
    significantly increase the capital requirement associated with
    various financial instruments that contributed to losses at
    systemically important institutions during the crisis; b)
    enhanced and higher capital charges for counterparty credit
    risk, including a new charge for credit valuation allowances
    (CVA), which were a significant source of loss during the
    crisis; and c) new liquidity standards, which directly address
    a major challenge during the global turmoil. With regard to the
    latter, the proposed standards draw heavily from conceptual
    design work contributed by Federal Reserve staff. In addition,
    Federal Reserve staff made significant contributions to the
    Basel Committee's Principles for Sound Liquidity Risk
    Management and supervision issued in September 2008. In many
    cases, the international principles articulated drew heavily
    from established Federal Reserve guidance. Moreover, Federal
    Reserve economists and supervisors have been heavily involved
    in work conducted by the Basel Committee and by the Committee
    of Global Financial Stability to develop forward-looking
    measures of systemic liquidity risks and in assessing the
    current state of funding and liquidity risk management at
    internationally active financial institutions.
        Federal Reserve staff also are key players in the Basel
    Committee's working groups developing a new international
    leverage ratio standard, which is largely inspired by the U.S.
    leverage standard, and a new definition of regulatory capital
    for banking organizations, which is an area where the Federal
    Reserve provides insightful experience since almost all banking
    capital issuance in the U.S. is executed at the bank holding
    company level.\1\ Moreover, the Federal Reserve has also played
    an active role in the Basel Committee's working group that
    recently issued recommendations to strengthen the resolution of
    systemically significant cross-border banks.\2\
    ---------------------------------------------------------------------------
        \1\ See ``Strengthening the resilience of the banking sector-
    consultative document'' (December 2009), available at www.bis.org/publ/
    bcbs164.htm.
        \2\ See ``Report and recommendations of the Cross-border Bank
    Resolution Group-final paper'' (March 2009), available at www.bis.org/
    publ/bcbs169.htm.
    ---------------------------------------------------------------------------
    Q.7.b. Could you define a ``systemically critical'' firm and
    identify how many such firms currently operate in the United
    States?

    A.7.b. A ``systemically critical'' firm is one whose failure
    would have significant adverse effects on financial markets or
    the economy. At any point in time, the systemic importance of
    an individual firm depends on a wide range of factors including
    whether the firm has extensive on- and off-balance sheet
    activities, whether the firm is interconnected--either
    receiving funding from, or providing funding to other
    systemically important firms--whether the firm plays a major
    role in key financial markets, and/or whether the firm provides
    crucial services to its customers that cannot easily or quickly
    be provided by other financial institutions. That said, the
    identification of systemic importance requires considerable
    judgment because each stress event is different, because market
    structure, business practices, financial products,
    technologies, supervisory practices and regulatory environments
    evolve over time. This evolution, of course, changes the
    interconnections between firms, their relative sizes, their
    functions and services, and the extent to which services can be
    obtained from other firms or in financial markets. As a
    practical matter, it is likely that the number of firms that
    are considered systemically critical will be less than 50. For
    example, only about 35 U.S. financial firms, with publicly
    traded stock outstanding, have total assets over $100 billion
    as of 2008:Q4.
                                    ------

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

    Bank Lending

    Q.1. I have heard from Ohio banks that banking regulators are
    preventing them from expanding commercial lending by requiring
    them to maintain greater capital reserves. I agree that we need
    to ensure that our banks are well capitalized, but at some
    point we've got to get lending going again, particularly to
    businesses that will use their money to hire workers.
        How can banks strike a balance between being well
    capitalized and still lending like they are supposed to?

    A.1. The loss absorbing characteristics of capital provide the
    economic bedrock that supports prudent bank lending and, as
    such, it is not inconsistent for banks to remain well
    capitalized and concomitantly engage in healthy lending
    practices. However, during the financial crisis, many banks
    recorded significant financial losses that eroded their capital
    base and as a result, some banks may be operating with reduced
    capital bases to support lending activities. In other
    instances, well capitalized banks may be reluctant to lend if
    their outlook on economic conditions lead them to believe that
    additional losses are likely in the near term, which would
    further erode their current capital position. The Federal
    Reserve believes that, in cases where banks are concerned about
    potential additional losses, a prudent response would be for
    those banks to increase their capital position in order to
    address this concern and to take advantage of any demand in
    commercial lending. Likewise, we believe that an improving
    economic outlook should help banks to bolster their capital
    levels and contribute to increased willingness of banks to
    lend.

    Q.2. Have you considered taking any specific steps, like
    lowering the Fed's interest payments on excess bank reserves,
    or perhaps even imposing a penalty on hoarding money, to
    promote greater lending?

    A.2. The Federal Reserve's payment of interest on excess
    reserves is unlikely to be a significant factor in banks'
    current reluctance to lend. The Federal Reserve is currently
    paying interest at a rate of only one quarter of 1 percent on
    banks' reserve balances. By contrast, the prime rate is
    currently at 3 \1/4\ percent, and many bank lending rates are
    considerably higher than the prime rate. Given the large
    difference between the interest rate paid on excess reserves
    and the interest rates on banks, the ability to earn interest
    on excess reserves is unlikely to be an important reason for
    the tightening of banks' lending standards and terms over the
    past few years. Indeed, survey results suggest that the major
    reason that banks have tightened lending terms and standards
    over the past 2 years or so was their concern about the
    economic outlook. As you know, the Federal Reserve has acted
    aggressively from the outset of the financial crisis to
    stabilize financial market conditions and promote sustainable
    economic growth. An improving economic outlook should
    contribute to increased willingness of banks to lend.

    Bank Concentration

    Q.3. Banks are borrowing at record low interest rates--
    particularly those banks that are viewed as ``too big to
    fail.'' According to the Center for Economic and Policy
    Research, the 18 biggest banks are getting what amounts to a
    $34.1 billion a year subsidy because of their implicit
    government guarantee. More recent data from the FDIC shows that
    big banks are turning a profit, but small banks are not. Data
    from 1999 shows that large banks' fees for overdrafts are 41
    percent higher than at small banks and bounced check fees are
    43 percent higher. Now borrowers are having their lines of
    credit slashed and their bank fees are still increasing.

        So it appears that consumers and small banks are suffering,
    while the big banks thrive. And the market is only getting more
    concentrated: 319 banks were forced to merge or fail in 2009.

        What steps are the Fed taking to ensure that there is not
    excessive concentration in the banking industry, and that
    consumers are being well served through meaningful competition?

    A.3. The Riegle-Neal Interstate Banking and Branching
    Efficiency Act (IBBEA) of 1994 provides prudential protection
    against excessive concentration in the banking industry by
    prohibiting the Federal Reserve from approving a bank
    acquisition that would result in a bank holding company
    exceeding a nationwide deposit concentration limitation of more
    than 10 percent of the total amount of deposits of insured
    depository institutions in the United States.
        Notwithstanding that protection, there are many other
    potential methods to address the subsidies that may arise
    because of perceptions that large financial firms are ``too-
    big-to-fail.'' For example, firms that might reasonably be
    considered ``too-big-to-fail'' may be subject to higher capital
    (and liquidity) requirements, more highly tailored resolution
    mechanisms, tighter deposit share caps, required issuance of
    contingent capital instruments and/or subordinated debt
    instruments, limitations on, or a ban of, certain activities
    (e.g., hedge funds or private equity funds), and taxes on non-
    deposit balance-sheet liabilities. As the financial crisis
    winds down, many of these types of proposals to reduce the
    subsidies that arise from implicit guarantees are under
    consideration in the United States and abroad. In fact, Federal
    Reserve staff are participating on many international working
    groups that are considering the potential effects, including
    unintended consequences, that may arise from implementing such
    proposals either singularly, or in combination. A key factor in
    such analyses is the impact on competition here in the United
    States and internationally across borders.
        Research on whether consumers benefit from ``too-big-to-
    fail'' subsidies is scant. It is plausible that large financial
    institutions might pass along some of their subsidies to
    consumers to fuel their own growth at the expense of smaller
    peers. Some evidence, however, suggests otherwise. For example,
    Passmore, Burgess, Hancock, Lehnert, and Sherlund (in a
    presentation at the Federal Reserve Bank of Chicago Bank
    Structure Conference, May 18, 2006) estimate that just 5
    percent of the Fannie Mae and Freddie Mac's borrowing advantage
    flowed through to mortgage rates, resulting in just a few basis
    points reduction in conforming mortgage loan rates. Even if
    financial firms do not pass along their ``too-big-to-fail''
    subsidies to consumers, it does not necessarily imply that they
    cannot pass along the higher costs that would result from the
    reduction of such subsidies. Indeed, larger firms may set the
    market prices for some financial products because of other cost
    advantages associated with their size. In such circumstances,
    consumers may end up paying higher prices when ``too-big-to-
    fail'' subsidies are reduced (or eliminated) even though they
    did not previously much benefit from such subsidies. That said,
    all consumers benefit from a more stable financial system with
    less systemic risk and this is the goal of reducing or
    eliminating ``too-big-to-fail'' subsidies.

    Resolution of Failed Banks

    Q.4. You have previously said that you favor ``establishing a
    process that would allow a failing, systemically important non-
    bank financial institution to be wound down in any orderly
    fashion, without jeopardizing financial stability.'' There's
    been a lot of talk about whether this job should be done by
    banking regulators or a bankruptcy court.
        Do you have an opinion about this, particularly whether the
    FDIC is doing a good job with its resolution authority?

    A.4. In most cases, the Federal bankruptcy laws provide an
    appropriate framework for the resolution of nonbank financial
    institutions. However, the bankruptcy code does not
    sufficiently protect the public's strong interest in ensuring
    the orderly resolution of a nonbank financial firm whose
    failure would pose substantial risks to the financial system
    and to the economy.
        A new resolution regime for systemically important nonbank
    financial firms, analogous to the regime currently used by the
    Federal Deposit Insurance Corporation for banks, would provide
    the government the tools to restructure or wind down such a
    firm in a way that mitigates the risks to financial stability
    and the economy and thus protects the public interest. It also
    would provide the government a mechanism for imposing losses on
    the shareholders and creditors of the firm. Establishing
    credible processes for imposing such losses is essential to
    restoring a meaningful degree of market discipline and
    addressing the ``too-big-to-fail'' problem.
        It would be appropriate to establish a high standard for
    invocation of this new resolution regime and to create checks
    and balances on its potential use, similar to the provisions
    governing use of the systemic risk exception to least-cost
    resolution in the Federal Deposit Insurance Act (FDI Act). The
    Federal Reserve's participation in this decisionmaking process
    would be an extension of our long-standing role in protecting
    financial stability, involvement in the current process for
    invoking the systemic risk exception under the FDI Act, and
    status as consolidated supervisor for large banking
    organizations. The Federal Reserve, however, is not well
    suited, nor do we seek, to serve as the resolution agency for
    systemically important institutions under a new framework.
    Because the suitability of an entity to serve as the resolution
    agency for any particular firm may depend on the firm's
    structure and activities, the Treasury Department should be
    given flexibility to appoint a receiver that has the requisite
    expertise to address the issues presented by a wind down of
    that firm.

    Banks Trading Commodities Futures Derivatives

    Q.5. You gave an address at Harvard in 2008 in which you talked
    about out-of-control crude oil prices. You said that ``demand
    growth and constrained supplies'' were responsible for
    ``intense pressure on [gas] prices.'' Senator Carl Levin
    investigated the crude oil market and found that speculation
    ``appears to have altered the historical relationship between
    [crude oil] price and inventory.'' In 2003, at the request of
    Citigroup and UBS, the Fed authorized bank holding companies to
    trade energy futures, both on exchanges and over-the-counter.
        Given that commodity prices affect the Consumer Price
    Index, which affects inflation, have you investigated what
    effect the rule change, and the resulting investments in
    commodities futures and other commodities-related derivatives,
    have had on oil prices?

    Q.6. If not, how can you conclude that rises in gasoline prices
    are due solely to simple changes in supply and demand?

    Q.7. If presented with evidence that energy speculation was
    driving up prices or affecting inflation, would you consider
    revoking the banks' authority to trade energy futures?

    A5.-7. The broad movements in oil and other commodity prices
    have been in line with developments in the global economy. They
    rose when global growth was strong and supply was constrained.
    and they collapsed with the onset of the global recession. As
    the global economy began to recover and financial conditions
    began to normalize, commodity prices rebounded.
        Nonetheless, the extreme price swings, particularly in the
    case of oil, have been surprising. Some have argued that
    speculative activities on the part of financial investors have
    been responsible for these outsized price movements.
    Notwithstanding considerable study, however, conclusive
    evidence of the role of speculators and financial investors
    remains elusive. The fundamentals of supply and demand, along
    with expectations for how these fundamentals will evolve in the
    future, remain the best explanation for the movements in
    commodity prices. That said, we must remain open to other
    possibilities, and if conclusive evidence emerged that
    commodity markets were not performing their price discovery and
    allocative role effectively, then changes in regulatory
    policies may be appropriate.

    Fed Purchases of Foreign Currency Derivatives

    Q.8. In the wake of the Greek debt crisis, I'm concerned about
    governments' use of foreign currency exchanges--that other
    governments might be using foreign currency swaps to mask their
    debt, or for other purposes. We know that the Federal Reserve
    entered into swaps with Foreign Central Banks and then those
    Foreign Central Banks bailed out their own banking systems. For
    example, the Federal Reserve worked with the Swiss central bank
    on the rescue effort for UBS, securing dollars through a swap
    agreement for francs. As of December 31, 2008, the United
    States had entered into $550 billion in liquidity swaps with
    foreign central banks.
        How are these arrangements between the Federal Reserve and
    the other central banks structured?

    A.8. The dollar liquidity swap arrangements that the Federal
    Reserve entered into with foreign central banks were
    fundamentally different from the currency swaps that have been
    discussed in the Greek context. According to reports, the Greek
    cross-currency swaps were highly structured arrangements
    initiated 8 or 9 years ago between the government of Greece and
    a private sector financial institution. These swaps apparently
    entailed payment obligations over a period of 15 to 20 years
    with large balloon payments at maturity, and they allowed the
    Greek government to exchange into euros the proceeds of
    borrowing it had done in Japanese yen and U.S. dollars at off-
    market rates of exchange.
        The dollar liquidity swaps, the volume of which is now zero
    following the termination of the arrangements in February, were
    more straightforward, shorter-term arrangements with foreign
    central banks of the highest credit standing. In each dollar
    liquidity swap transaction, the Federal Reserve provided U.S.
    dollars to a foreign central bank in exchange for an equivalent
    amount of funds in the currency of the foreign central bank,
    based on the market exchange rate at the time of the
    transaction. The parties agreed to swap back these quantities
    of their two currencies at a specified date in the future,
    which was at most 3 months ahead, using the same exchange rate
    as in the initial exchange. The Federal Reserve also received
    interest corresponding to the maturity of the swap drawing.
        Because the terms of each swap transaction were set in
    advance, fluctuations in exchange rates following the initial
    exchange did not alter the eventual payments. Accordingly,
    these swap operations carried no exchange rate or other market
    risks. In addition, we judged our swap line exposures to be of
    the highest quality and safety. The foreign currency held by
    the Federal Reserve during the term of the swap provided an
    important safeguard. Furthermore, our exposures were not to the
    institutions ultimately receiving the dollar liquidity in the
    foreign countries but to the foreign central banks. We have had
    long and close relationships with these central banks, many of
    which hold substantial quantities of U.S. dollar reserves in
    accounts at the Federal Reserve Bank ofNew York, and these
    dealings provided a track record that justified a high degree
    of trust and cooperation. The short tenor of the swaps, which
    ranged from overnight to 3 months at most, also offered some
    protection, in that positions could be wound down relatively
    quickly were it judged appropriate to do so.

    Q.9. Are these swaps being used in any way to mask U.S.
    Government debt?

    A.9. No. These swaps were limited to the exchange of U.S.
    dollar liquidity for foreign-currency liquidity and were not
    used in any way to mask U.S. Government debt.

    Q.10. Does the Federal Reserve keep track of which foreign
    banks ultimately receive U.S. money from foreign central banks?
    If so, what banks have gotten U.S. money, and how much has each
    gotten?

    A.10. The Federal Reserve's contractual relationships were with
    the foreign central banks and not with the financial
    institutions ultimately obtaining the dollar funding provided
    by these operations. Accordingly, the Federal Reserve did not
    track the names of the institutions receiving the dollar
    liquidity from the foreign central banks but instead left to
    the foreign central banks the responsibility for managing the
    distribution of the dollar funding. This responsibility
    included determining the eligibility of institutions that could
    participate in the dollar lending operations, assessing the
    acceptability of the collateral offered, and bearing any
    residual credit risk that might have arisen as a result of the
    lending operations.

    Q.11. Is the U.S. Treasury issuing Treasury bonds which the Fed
    is then buying through the U.K. or other foreign governments?

    A.11. No.
                                    ------

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

    Q.1. The homeownership rate in Canada is almost identical to
    that of the United States. Yet the percentage of U.S. mortgages
    in arrears is fast approaching 10 percent while the percentage
    of Canadian mortgages in arrears has been relatively stable for
    the past two decades at less than 1 percent. What
    characteristics of the mortgage market in Canada do you believe
    have helped that country avoid a similar foreclosure crisis?

    A.1. A number of characteristics of the Canadian mortgage
    market helped Canada avoid a foreclosure crisis. Canadian
    homeowners typically maintain greater equity in their homes, in
    part because mortgage insurance, which is required when loan-
    to-value ratios exceed 80 percent, is more costly than in the
    United States. Moreover, Canadian mortgages are subject to
    substantial pre-payment penalties, reducing the incentives of
    households to regularly refinance their mortgages. While in
    general this limits households' ability to take advantage of
    falling interest rates, it also reduces the number of ``cash
    out'' refinancings, increasing the average equity held by
    households.
        In addition, a greater fraction of Canadian mortgages are
    prime mortgages, which default at lower rates than sub-prime
    mortgages. One reason the sub-prime market was slower to grow
    in Canada is because of the incentives, noted above, for
    borrowers to make higher down payments. Another reason is that
    a smaller fraction of mortgages in Canada are securitized,
    because even mortgages that have been securitized and resold
    carry a capital charge, giving Canadian banks less incentive to
    securitize mortgages. A mortgage lender that plans to hold a
    mortgage to maturity likely employs higher underwriting
    standards than a mortgage lender that plans to securitize the
    loan.
        Finally, Canada has experienced a comparatively milder
    labor-market downturn than the United States and only a modest
    decline in house prices. These factors, too, have helped reduce
    the incidence of default.

    Q.2. All of the six major banks in Canada own investment
    banking and insurance subsidiaries. All five of the major banks
    in Canada would probably be considered ``too-big-to-fail.''
    However, the Canadian banking regulators have prudently
    enforced more stringent capital requirements including a 7
    percent minimum of Tier 1 capital and 10 percent minimum of
    total capital. Additionally, there is an Assets-to-Capital
    Multiple maximum of 20 (or leverage ratio).
        What lessons have you learned from observing the actions
    that Canadian regulators have taken regarding the use of more
    stringent capital requirements than those required under Basel
    II?

    A.2. At present, the U.S. regulatory capital rules result in a
    requirement for banking organizations to hold capital at levels
    that are equal to, or exceed, Canadian peers; notwithstanding
    that the stated required minimum Tier 1 risk-based capital
    ratio is 6 percent for ``well capitalized'' banks under PCA.\1\
    Because of statutorily required responses to the breeching of a
    PCA capital threshold, market forces generally necessitate
    banks and bank holding companies to hold substantially more
    capital than the ``well capitalized'' ratio requirements to
    ensure that significant losses can be absorbed before a ``well
    capitalized'' ratio is breached. The following table outlines
    the Tier I, Total and Leverage ratios of the top six U.S. bank
    holding companies and provides our estimate of their respective
    Assets-to-Capital Multiple as computed under the Canadian
    regulatory capital regime. As shown below, each of the top six
    U.S. bank holding companies would easily exceed the Canadian
    standards outlined above.
    ---------------------------------------------------------------------------
        \1\ To be considered ``well capitalized'' under the U.S. Prompt
    Corrective Action (PCA) requirements, a bank must have a Tier 1
    Leverage ratio of no less than 5 percent, a Tier I risk-based capital
    ratio of no less than 6 percent, a Total risk-based capital ratio of no
    less than 10 percent.

                                                 Selected Capital Ratios
                                         Six Largest U.S. Bank Holding Companies
                                                (as of December 31, 2009)
    ----------------------------------------------------------------------------------------------------------------
                                                                                             Assets-to-
                                                                                               Tier 1
                                                                                              Capital     Assets-to-
                                                     Tier 1 Risk- Total Risk-     Tier 1      Multiple     Capital
                                                        Based        Based       Leverage   (Inverse of    Multiple
                                                       Capital      Capital       Ratio         U.S.      (Canadian
                                                                                              Leverage   Definition)
                                                                                               Ratio)
    ----------------------------------------------------------------------------------------------------------------
    Bank of America................................       10.41%       14.67%        6.91%         14.5         11.6
    JP Morgan Chase................................       11.10%       14.78%        6.88%         14.5         13.7
    Citigroup......................................       11.67%       15.25%        6.89%         14.5         12.7
    Wells Fargo....................................        9.25%       13.26%        7.87%         12.7          9.6
    Goldman Sachs..................................       14.97%       18.17%        7.55%         13.2         12.3
    Morgan Stanley.................................       15.30%       16.38%        5.80%         17.2         17.1
    ----------------------------------------------------------------------------------------------------------------

        The Federal Reserve believes that, going forward, capital
    requirements will need to be recalibrated to directly address
    the inappropriate incentives that were the underlying causes of
    the financial crisis. We are engaged in a significant effort
    both here in the United States and abroad to achieve this
    objective.

    Q.3. Canada has an independent consumer protection agency,
    called the Consumer Financial Agency of Canada. Do you believe
    that this agency's mission and independence has helped the
    Canadian financial markets remain stable and well capitalized,
    even under the current economic conditions?

    A.3. Consumer protection laws are very important for
    maintaining a well-functioning financial system. The Financial
    Consumer Agency of Canada (FCAC) is responsible for ensuring
    compliance with consumer protection laws and regulations;
    monitoring financial institutions' compliance with voluntary
    codes of conduct; and informing consumers of their rights and
    responsibilities as well as providing general information on
    financial products.
        Ensuring compliance with consumer protection laws is an
    important defense against future financial problems, and
    informed consumers are undoubtedly less likely to enter
    unfavorable mortgage agreements. It is difficult to gauge,
    however, the extent to which the quality of consumer
    information and extent of consumer protection help explain why
    Canada had relatively few of the exotic, hard-to-understand
    sub-prime mortgages that have had such high default rates in
    the United States. As noted in the answer to the preceding
    question, other factors--the structure of the mortgage market
    and bank capital regulation in Canada--appear to represent more
    tangible reasons why the sub-prime market was slow to develop
    in Canada.

    Q.4. Throughout the past year, many witnesses before the Senate
    Banking Committee have argued that the widespread practice of
    securitizing mortgages helped propagate bad underwriting
    practices and contributed to the toxic nature of many, if not
    all, investments in subprime mortgages. The Canadian mortgage
    market only has approximately 5 percent of outstanding
    mortgages categorized as ``subprime.'' Additionally, according
    to the Bank of Canada, 68 percent of mortgages remain on the
    balance sheet of the lender and most residential mortgage
    financing is funded through deposits. Do you think that banks
    who keep major portions of their residential real estate
    lending ``on the books'' are less likely to engage in the
    financing of, ``subprime'' mortgage lending?

    A.4. It is unlikely that a requirement to keep mortgage
    exposures on balance sheet would make banking organizations
    less likely to underwrite ``subprime'' exposures. For instance,
    prior to the financial crisis, many banking organizations
    entered into ``subprime'' mortgage securitizations and retained
    the ``first loss'' positions ``on the books,'' reflecting a
    high risk tolerance for exposure to the ``subprime'' mortgage
    market. Additionally, many other banking organizations provided
    recourse on ``subprime'' mortgage exposures that they sold to
    securitization structures; again, a reflections of a high risk
    tolerance ``subprime'' mortgage exposures. If banking
    organizations were no longer allowed to place ``subprime''
    mortgages into securitization vehicles, it could be reasonably
    posited that banking organizations would continue to underwrite
    ``subprime'' mortgages given the higher yield earned from these
    exposures and the fact that the current risk-based capital
    framework levies an identical capital requirement for a
    ``subprime'' exposure as it does for a ``prime'' exposure.
        There are several distinct differences between the U.S. and
    Canadian mortgage markets that raise difficulty in using the
    Canadian experience as a comparator. For example, the Canada
    Mortgage and Housing Corporation (CMHC), which serves a similar
    function as Freddie and Fannie, is guaranteed by the full faith
    and credit of Canada, in the same manner as GNMA is guaranteed
    by the United States. As a result, banking organizations that
    invest in securitization structures through the CMHC are
    required to hold no regulatory capital against their investment
    (0 percent risk-weight exposure), versus in the United States
    where banking organizations must risk-weight exposures to
    Freddie or Fannie at 20 percent. In addition, Canadian banking
    organizations are required to obtain private mortgage insurance
    (PMI) for all mortgages with a loan-to-value ratio over 80
    percent and they must maintain the PMI for the life of the
    loan, regardless of any subsequent reduction in a mortgage's
    LTV that may result from loan repayment or house appreciation.
    However, banks that rely on private mortgage insurers receive a
    government guarantee against losses that exceed 10 percent of
    the original mortgage in the event of an insurer failure. As a
    result, Canadian banking organizations are required to hold
    relatively little capital against mortgage exposures that are
    held on balance sheet--either through on-balance sheet mortgage
    portfolios or through investments in CMHC securitizations.
        The market for ``subprime'' mortgages was all but ended for
    Canadian banking organizations in 2008 when the CMHC decided to
    no longer insure ``subprime'' mortgages. This provided a
    significant regulatory capital disincentive for Canadian
    banking organizations to underwrite ``subprime'' mortgages.
                                    ------

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

    Q.1. Treasury recently announced they were starting up the
    Supplemental Financing Program again. Under that Program,
    Treasury issues debt and deposits the cash with the Fed. That
    is effectively the same thing as the Fed issuing its own debt,
    which is not allowed. What are the legal grounds the Fed and
    Treasury use to justify that program? And did anyone in the Fed
    or Treasury raise objections when the program was created?

    A.1. Section 15 of the Federal Reserve Act requires the Federal
    Reserve to act as fiscal agent for the United States and
    authorizes the Treasury to deposit money held in the general
    fund of the Treasury in the Federal Reserve Banks. Balances
    held by the Reserve Banks in the Treasury's Supplementary
    Financing Account (SFA) are deposited and held under this
    authority. Although the Treasury and the Federal Reserve have
    consulted closely on matters regarding the Supplemental
    Financing Program (SFP), the Treasury makes all decisions on
    balances to be held in the SFA.
        I am not aware of any staff member or policymaker raising
    legal objections to the creation of the SFP. However, at least
    one Federal Reserve policymaker has publicly expressed policy
    concerns with the SFP. See Real Time Economics, WSJ Blogs,
    ``Q&A: Philly Fed's Plosser Takes on `Extended Period'
    Language,'' March 1, 2010.

    Q.2. Given what you learned during the AIG crisis and bailout,
    do you think Congress should be doing something to address
    insurance regulation or the commercial paper market?

    A.2. The financial crisis has made clear that all financial
    institutions that are so large and interconnected their failure
    could threaten the stability of the financial system and the
    economy must be subject to consolidated supervision. Lack of
    strong consolidated supervision of systemically critical firms
    not organized as bank holding companies, such as AIG, proved to
    be a serious regulatory gap. The Federal Reserve strongly
    supports ongoing efforts in the Congress to reform financial
    regulation and close existing gaps in the regulatory framework.
        An effective framework for financial supervision and
    regulation also must address macroprudential risks--that is,
    risks to the financial system as a whole. The disruptions in
    the commercial paper market following the failure of Lehman
    Brothers on September 15, 2008 and the breaking of the buck by
    a large money fund the following day are examples of such
    macroprudential risks.
        Legislative proposals in both the House and Senate would
    also improve the exchange of information and the cross-
    fertilization of ideas by creating an oversight council
    composed of representatives of the agencies and departments
    involved in the oversight of the financial sector that would be
    responsible for monitoring and identifying emerging systemic
    risks across the full range of financial institutions and
    markets. The council would have the ability to coordinate
    responses by member agencies to mitigate identified threats to
    financial stability and, importantly, would have the authority
    to recommend that its member agencies, either individually or
    collectively, adopt heightened prudential standards for the
    firms under the agencies' supervision in order to mitigate
    potential systemic risks.

    Q.3.a. When did you know that AIG's swaps partners were going
    to be paid off at effectively par value in the Maiden Lane 3
    transaction?

    Q.3.b. Did you or the Board approve the payments?

    A.3.a.-b. I was not directly involved in the negotiations with
    the counterparties that sold multi-sector collateralized debt
    obligations (``CDOs'') to Maiden Lane III LLC (``ML III'') in
    return for termination of credit default swaps AIG had written
    on those CDOs. These negotiations were handled by the staff of
    the Federal Reserve Bank of New York (``FRBNY''). I
    participated in and support the final action of the Board to
    authorize lending by the FRBNY to ML III for the purpose of
    purchasing the CDOs in order to remove an enormous obstacle to
    AIG's financial stability and thereby help prevent a disorderly
    failure of AIG during troubled economic times.
        As explained in the testimony of Thomas Baxter, Executive
    Vice President and General Counsel, FRBNY, before the Committee
    on Oversight and Government Reform on January 27, 2010, the
    Federal Reserve loan to ML III was used by ML III to purchase
    the multi-sector CDOs underlying AIG's CDS at their current
    market value (approximately $29 billion), which represented a
    significant discount to their par value ($62 billion).
    Collateral already posted by AIG (not ML III) under the terms
    of the CDS contracts was also relinquished by AIG in return for
    tearing-up the contracts and freeing AIG of further obligations
    under the CDS contracts. Before agreeing to the transaction,
    the Federal Reserve consulted independent financial advisors to
    assess the value of the underlying CDOs and the expectation
    that the value of the CDOs would be recovered. The advisors
    believed that the cash flow and returns on the CDOs would be
    sufficient, even under highly stressed conditions, to fully
    repay the Federal Reserve's loan to ML III. Under the terms of
    the agreement negotiated with AIG, the Federal Reserve will
    also receive two-thirds of any profits received on the CDOs
    after the Federal Reserve's loan and AIG's subordinated equity
    position are repaid in full.

    Q.3.c. When did you find out about the cover-up of the amount
    of the payments?

    Q.3.d. Did you approve of the efforts to cover up the amount of
    the payments?

    Q.3.e. If you did not approve of the cover-up at the time, do
    you believe that it was the right decision?

    A.3.c.-e. The amount of the payments to the CDS counterparties
    was fully disclosed by AIG. Moreover, the Federal Reserve fully
    disclosed the amount of its loan to ML III and the fair value
    of the assets that serve as collateral for that loan in both
    the weekly balance sheet of the Federal Reserve (available on
    the Board's website) and in the Board's reports to Congress as
    required by law.
        AIG was at all times responsible for complying with the
    disclosure requirements of the various securities laws. I was
    not involved in the discussions between the Federal Reserve and
    AIG related to AIG's securities law filings. I fully supported
    AIG's decision to release publicly in March 2009 the identities
    of these counterparties.

    Q.4. The Fed has been out in the press talking about how they
    are going to make money on their AIG loans, making it sound
    like a good deal for the taxpayers. However, that is not the
    whole story because Treasury has committed some $70 billion to
    the AIG bailout. So the taxpayers are still exposed to AIG, and
    in fact are likely to take losses. Do you agree that the Fed's
    exposure to AIG is not the whole story and the taxpayers are
    likely to face losses from the AIG bailout?

    A.4. As you know, the Federal Reserve provided liquidity to AIG
    through direct line of credit and through loans provided to two
    Maiden Lane facilities that funded certain assets of AIG.
    Extensive information about each of these credits is available
    on the Board's website and in reports and testimony provided by
    the Federal Reserve to Congress. Based on analysis of the
    collateral supporting these loans by experienced third-party
    advisors and the FRBNY, the Federal Reserve expects to be fully
    repaid on each of these credits, with no loss to the taxpayers.
        The Treasury Department has provided equity to AIG. Like
    the liquidity provided by the Federal Reserve, this equity was
    provided in order to prevent the disorderly collapse of AIG
    during a period of extreme financial stress that could have
    caused significant economic distress for policy holders,
    municipalities, and small and large businesses, and led to even
    greater financial chaos and a far deeper economic slump than
    the very severe one we have experienced.

    Q.5. Did you or the Board approve of then New York, Fed
    President Geithner staying on at the New York Fed while working
    for the Obama transition team? If yes, why did you think that
    was a good idea?

    A.5. Timothy Geithner was appointed President of the Federal
    Reserve Bank of New York for a 5-year term that extended until
    February 28, 2011. When President Geithner was asked by the
    President-elect of the United States to serve as Secretary of
    the Treasury, President Geithner withdrew from the Bank's day-
    to-day management pending his confirmation by the Senate. He
    also relinquished his Federal Open Market Committee (FOMC)
    responsibilities which were assumed by Christine Cumming, the
    Reserve Bank's alternate representative elected in accordance
    with the Federal Reserve Act. President Geithner did not attend
    the December 2008 FOMC meeting. Ms. Cumming served as a voting
    member of the FOMC until President Geithner's successor took
    office. It was expected that President Geithner would continue
    to serve as President of the Reserve Bank at least through the
    end of his term if he did not become Secretary of the Treasury.

    Q.6. Is the Fed now, or has the Fed in recent years, purchased
    Greek Government or bank debt?

    A.6. The Federal Reserve has not purchased debt of the
    government of Greece nor has the Federal Reserve purchased the
    debt of any Greek financial institution. Detailed information
    on the Federal Reserve's foreign exchange holdings, both
    currency and investments, is available in the quarterly
    Treasury and Federal Reserve Foreign Exchange Operations report
    published by the Federal Reserve Bank of New York. See http://
    www.newyorkfed.org/markets/quar_reports.html.

    Q.7. Unemployment numbers continue to bounce up and down every
    week. As this year goes on, the Census is going to be hiring
    700,000 to 800,000 workers on a temporary basis. Are you
    worried those numbers will distort the true jobs picture, and
    that economic forecasts that use those jobs numbers will be
    wrong?

    A.7. As you suggest, hiring of temporary workers by the U.S.
    Bureau of the Census in support of the decennial census will
    elevate the total payroll employment counts reported by the
    Bureau of Labor Statistics (BLS) each month because these
    temporary workers are included in Federal Government employment
    in the Current Employment Statistics (CES) survey. However, I
    do not think that Census hiring will make it much more
    difficult than usual to interpret the monthly employment
    reports. The BLS is publishing information each month on the
    number of temporary census workers in the CES data, and thus it
    will be straightforward to adjust the data to calculate the
    monthly changes in payroll employment excluding the effects of
    Census hiring; moreover, Census hiring will not distort the BLS
    estimates of employment change in the private sector. In
    addition, the Bureau of the Census has made available its
    hiring plans for coming months, which economic forecasters can
    use in making their projections of employment changes for the
    remainder of this year. Although these plans are subject to
    change, based on this information, the Department of Commerce
    expects the effect on the level of payroll employment reported
    by the BLS to peak at about 635,000 jobs in May 2010 and to
    fall back to roughly 25,000 jobs by September. The extent to
    which Census hiring reduces the measured unemployment rate is
    more difficult to estimate because that effect depends on the
    prior labor force status of the temporary Census workers.
    However, based on the employment estimates, the peak effect on
    the unemployment rate in May would probably be between \1/4\
    and \1/2\ percentage point.

    Q.8. Please explain how term deposits and reverse repo
    transactions are not the economic equivalent of the Fed issuing
    debt.

    A.8. There are a number of similarities and differences between
    term deposits, reverse repurchase agreements and agency debt
    obligations. In principle, each could be used to drain reserves
    from the financial system in order to reduce the potential for
    inflation and thereby maintain price stability. Indeed, various
    central banks use instruments similar to these to help manage
    interest rates and maintain price stability.
        In the United States, Congress has specifically authorized
    the Federal Reserve to accept deposits from depository
    institutions. (See 12 USC 342). Congress has also specifically
    authorized the Federal Open Market Committee to direct Reserve
    Banks to purchase and sell in the open market obligations of,
    or obligations guaranteed as to principal and interest by, the
    United States or its agencies. (See 12 USC 263 and 355).
    Reverse repurchase agreements represent the sale and purchase
    of obligations of, or obligations guaranteed as to principal
    and interest by, the United States or its agencies. Congress
    has not specifically authorized the Federal Reserve to issue
    its own agency debt obligations.
        Unlike deposits and reverse repurchase agreements, agency
    obligations are freely transferable. Term deposits may only be
    accepted from depository institutions and are not transferable.
    Reverse repurchase agreements also are not transferable and
    occur only with counterparties that are interested in
    purchasing qualifying government or agency securities.

    Q.9. Given that you have signaled that the Fed will be using
    the interest on reserves rate as a policy tool in the near
    future, do you believe that rate should be set by the Federal
    Open Market Committee rather than the Board of Governors?

    A.9. As you know, the Congress has assigned to the Board the
    responsibility for determining the rate paid on reserves.
    Although the Federal Open Market Committee (FOMC) by law is
    responsible for directing open market operations, the Congress
    has also assigned to the Board the responsibility for
    determining certain other important terms that are relevant for
    the conduct of monetary policy--for example, the Board
    ``reviews and determines'' the discount rates that are
    established by the Federal Reserve Banks; the FOMC has no
    statutory role in setting the discount rate. Similarly, the
    Board sets reserve requirements subject to the constraints
    established by the Congress; the FOMC has no statutory role in
    setting reserve requirements.
        For many years, the Board and the FOMC have worked
    collegially and cooperatively in setting the discount rate, the
    Federal funds target rate, and other instruments of monetary
    policy. I am convinced that the Board and the FOMC will
    continue to work cooperatively in the future in adjusting all
    of the instruments of monetary policy.