[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.
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