[Senate Hearing 111-742]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 111-742

 
        FEDERAL RESERVE'S SECOND 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

      OVERSIGHT ON THE MONETARY POLICY REPORT TO CONGRESS PURSU- 
       ANT TO THE FULL EMPLOYMENT AND BALANCED GROWTH ACT OF 1978

                               __________

                             JULY 21, 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

                       Amy Friend, Chief Counsel

                     Marc Jarsulic, Chief Economist

                   Julie Chon, Senior Policy Adviser

                   Lisa Frumin, Legislative Assistant

                Mark Oesterle, Republican Chief Counsel

                 Jeff Wrase, Republican Chief Economist

                Andrew Olmem, Republican Senior Counsel

                       Dawn Ratliff, Chief Clerk

                     Levon Bagramian, Hearing Clerk

                     William Fields, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                        WEDNESDAY, JULY 21, 2010

                                                                   Page

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

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     3
    Senator Bunning..............................................     4

                                WITNESS

Ben S. Bernanke, Chairman, Board of Governors of the Federal 
  Reserve System.................................................     5
    Prepared statement...........................................    48
    Responses to written questions of:
        Senator Schumer..........................................    72
        Senator Brown............................................    73
        Senator DeMint...........................................    74
        Senator Vitter...........................................    75
        Senator Hutchison........................................    79

              Additional Material Supplied for the Record

Monetary Policy Report to the Congress dated July 21, 2010.......    82

                                 (iii)


        FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2010

                              ----------                              


                        WEDNESDAY, JULY 21, 2010

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 2:03 p.m., in room SD-G50, Dirksen 
Senate Office Building, Senator Christopher J. Dodd (Chairman 
of the Committee) presiding.

       OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD

    Chairman Dodd. The Committee will come to order.
    We are here today to hear from the Chairman of the Federal 
Reserve on the semiannual monetary policy report to the 
Congress, and, Mr. Chairman, we welcome you to our Committee 
once again. We thank you for your service to our country, and 
at least on my part, let me thank you and congratulate you for 
the tremendous work you and the staff of the Federal Reserve 
have been doing through these very difficult days in our 
country, and we are very fortunate to have you, in my view, as 
the Chair.
    I want to make some brief opening comments, and then I will 
turn to Senator Shelby for any opening comments he may have, 
and I will leave it up to the members themselves--we do not 
have a full complement here, but there are several who would 
like to be heard briefly before we turn to you for your 
thoughts, and then the questions we will have for you this 
afternoon.
    Let me express my gratitude to the Chairman and the other 
Members of the Committee. Normally, we would have had this 
Committee hearing in the morning, and because of the bill-
signing ceremony this morning, we delayed it until this 
afternoon. So I appreciate you being able to accommodate us.
    We are pleased to welcome you again, Mr. Chairman, to the 
Committee. Today he will deliver his semiannual monetary policy 
report, as I have said, to the Congress. The timing of this 
testimony could not be better, in our view. Key questions about 
both financial regulation and our current economic policy will 
be answered in the coming months. The Federal Reserve will play 
a key role in answering both of those series of questions.
    Today the President, as many know, signed into law the Wall 
Street reform bill. This bill, in my view, is a comprehensive 
response to our financial crisis that devastated our economy. 
The bill demands that regulators change the oversight of the 
financial markets and financial institutions in very 
fundamental ways. It sets up a Financial Stability Oversight 
Council which will function as an early warning system, we 
hope, be responsible for spotting and addressing threats to the 
overall financial stability of our country and institutions and 
even in other nations around the world. It creates a new 
orderly liquidation authority to provide for the wind-down of 
large financial institutions whose failure threatens overall 
financial stability.
    Further, it makes the markets for financial derivatives 
much more transparent. It requires regulators to establish 
capital standards and margin requirements for large derivative 
dealers. That will reduce the risk, we believe, posed by these 
financial instruments.
    Further, it limits the ability of banks and their owners to 
engage in risky trading strategies or to invest in hedge funds 
or private equity funds. Further, it requires higher prudential 
standards, including capital and liquidity for large bank 
holding companies and nonbank financial firms that have the 
potential to put the financial system at risk.
    The bill establishes for the first time a Consumer 
Financial Protection Bureau with a mandate to focus exclusively 
on protecting consumers from financial abuses and ensuring that 
consumers get the financial information that they need in a 
form that they can understand.
    But while the bill gives regulators substantial new 
authority, it does not contain the specific regulations that 
will translate authority into action. Congress is not in the 
position to write them. It is above the capacity of this 
institution to do that. Those rules and regulations require 
expert knowledge, and they must adapt over time to changing 
circumstances. Congress must rely on regulatory agencies to 
implement the goals of this reform bill. However, it is the 
role of Congress to oversee the actions of our regulators, and 
given the importance of getting financial reform right, it is a 
role that should be pursued with great vigor, attention, and 
diligence in the coming months and years.
    The Federal Reserve is one of the institutions on which 
Congress will rely most heavily. The additional authority it 
has been given is remarkable in this bill. The Federal Reserve 
will be a member of the Oversight Council, and the insights of 
its supervisors and researchers will play an important part in 
identifying developing risks to the financial system. It will 
be the Fed's job to set the heightened prudential standards for 
the Nation's large banks and nonbank financial companies 
designated by the Oversight Council. The Fed will help to 
decide when a failing financial firm needs to be put into the 
new resolution process, and the Fed will have the 
responsibility to oversee important financial utilities, 
including, for example, the clearinghouses that will become 
increasingly central in derivatives markets.
    As you are aware, Mr. Chairman, I have been critical of the 
Fed's past performance and, in fact, advocated striking the 
Fed's supervisory role. While the Fed managed the financial 
crisis superbly, in my view, it did less well in the run-up to 
the crisis. It failed to use the authority in HOEPA to prevent 
the serious deterioration in mortgage underwriting standards 
and abusive and fraudulent mortgage lending practices that, in 
my view, fueled the financial crisis we have been going 
through. It also failed, in my view, to adequately supervise 
some of our largest bank holding companies. These holding 
companies were allowed to accumulate significant exposures to 
mortgage-related assets. The losses they suffered when the 
house price bubble burst helped to produce the financial crisis 
from which we have not yet fully recovered.
    However, as the financial reform bill worked its way 
through the legislative process, the Congress in its wisdom 
decided not only to preserve the Fed's existing supervisory 
power but to bolster it. Indeed, Mr. Chairman, you sought those 
additional powers, and as a result, the Fed is central to 
maintaining our financial stability.
    I think it is fair to say that the success of the financial 
reform law depends in large measure on how the Federal Reserve 
meets its new responsibilities. It is my fervent hope that 
under your stewardship the Fed will exercise these authorities 
wisely.
    Of course, the financial reform law left the Fed's 
responsibilities for monetary policy unchanged, and this gives 
the Fed even more crucial work to do. The devastation brought 
by the financial crisis is still with us, and while output has 
begun to grow, it is not growing rapidly enough to replace the 
millions of jobs lost during this crisis. In the first quarter 
of this year, GDP grew at an unimpressive 2.7 percent. The 
unemployment rate in June was still at 9.5 percent, and nearly 
7 million workers have been unemployed for 27 weeks or more.
    As you have acknowledged in previous testimony, Mr. 
Chairman, the effects of long-term unemployment, which destroys 
job skills and demoralizes those who suffer from it, has the 
potential to create serious long-term problems in our Nation. 
And although firms with access to credit markets are able to 
borrow at relatively low interest rates, the businesses and 
households that depend upon banks for credit continue to find 
difficulty in accessing credit. Apart from inventories, 
investment demand remains anemic, and real fixed investment 
declined in the first quarter of this year.
    In this less than robust environment, it is not surprising 
that price inflation is hardly an issue. Over the past year, 
the CPI has increased by only 1.1 percent, and core CPI has 
increased by only 0.9 percent. In short, it looks like our 
economy is in need of additional help. It is evident that the 
Fed takes this issue seriously, and I applaud you for that. The 
Federal funds rate is now near zero, and the banks are now 
sitting on extraordinary quantities of excessive reserves. But 
one of the issues I would like to explore with you today is 
whether the Fed can do more to help expand output and 
employment in our Nation.
    Now I would like to turn to my good friend and colleague, 
the former Chairman of the Committee, Senator Shelby, for any 
opening comments he may have.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Chairman Dodd. Welcome to the 
Committee again, Chairman Bernanke. You have been with us for 
many years now on many occasions.
    Mr. Chairman, judging by the minutes of the Fed's June Open 
Market Committee meeting and statements by Fed officials, 
uncertainty about the economic outlook has risen recently, and 
there is a growing divergence of views. Recent data suggests 
that the already modest recovery may have hit a soft patch.
    We have also recently experienced another flight to quality 
and elevated uncertainty given the events surrounding Greece 
and others. Although some concerns have waned, we should 
continue, I believe, to monitor the situation in Europe and 
learn from their fiscal difficulties.
    Given market uncertainties and the possibility of a double-
dip recession, there has been a modest change in the Fed's 
outlook as reflected in its recent policy discussions about 
whether inflation or deflation is the predominant current 
threat.
    There are questions about what the Fed's contingency plans 
are in the event of a double-dip recession or persistent 
deflationary pressures. There are questions about whether the 
Fed could combat deflationary pressures or whether the U.S. 
would have any experience like Japan. There are questions about 
whether the Fed has changed its focus from executing an exit 
strategy to lowering interest rates on reserves and possibly 
further ballooning its balance sheet with more asset purchases.
    This is especially concerning because the purchase of even 
more long-term assets may channel credit to favored segments of 
the markets at the expense of others.
    In the current environment in which the distinction between 
fiscal and monetary policy is sometimes blurred, Fed 
transparency about its plans I think is crucial. I believe that 
it is important for Congress to know what options are on the 
table and where the Fed may be headed. Chairman Bernanke, as 
the economic outlook has become a bit more cloudy of late, I 
look forward to hearing your views here today, and I am sure 
all of us have a number of questions for you.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator Shelby.
    Any of my colleagues want to be heard on this? Anyone here 
on the Democratic side? Senator Bunning.
    Senator Bunning. Very short.
    Chairman Dodd. Certainly.

                STATEMENT OF SENATOR JIM BUNNING

    Senator Bunning. It is amazing to me how two people can 
differ on a financial reserve law than the Chairman and myself. 
Some of us think that we did not do enough and we did not hit 
the heart of the problem. We did not touch Fannie Mae or 
Freddie Mac. Derivatives, credit default swaps, we just barely 
skimmed the top. And we did not do anything but put into the 
law too big to fail. So, Chairman, I am anxious to hear what 
the outlook for the economy is.
    Thank you, Mr. Chairman.
    Chairman Dodd. Anyone else wish to be heard? Any opening 
comments at all?
    Senator Corker. Mr. Chairman, I do not want to make an 
opening comment. I know you know that well. But how long is the 
Chairman going to be with us today, just so we can organize our 
thinking about questions? And how long will the question period 
be?
    Chairman Dodd. Well, a good part of the afternoon, my 
guess. I do not know. Votes on the floor may disrupt us. I do 
not know what the Majority and Minority Leaders' plans are for 
voting. I know there may be four or five votes at some point. 
And I think under the rules there are about 10 minutes--some 
five amendments that the minority has on the bill, and each 
amendment could take 10 minutes of debate, plus the vote 
itself. So I do not know when that will come. But that could 
disrupt the flow, I will tell you that much.
    Senator Corker. Do you expect one round or two, do you 
know?
    Chairman Dodd. I will stay as long as people want and try 
and get through as much as we can.
    Mr. Chairman, welcome.

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

    Mr. Bernanke. Thank you. Chairman Dodd, Senator Shelby, and 
Members of the Committee, I am pleased to present the Federal 
Reserve's semiannual Monetary Policy Report to the Congress.
    The economic expansion that began in the middle of last 
year is proceeding at a moderate pace, supported by stimulative 
monetary and fiscal policies. Although fiscal policy and 
inventory restocking will likely be providing less impetus to 
the recovery than they have in recent quarters, rising demand 
from households and businesses should help sustain growth. In 
particular, real consumer spending appears to have expanded at 
about a 2\1/2\-percent annual rate in the first half of this 
year, with purchases of durable goods increasing especially 
rapidly. However, the housing market remains weak, with the 
overhang of vacant or foreclosed houses weighing on home prices 
and construction.
    An important drag on household spending is the slow 
recovery in the labor market and the attendant uncertainty 
about job prospects. After 2 years of job losses, private 
payrolls expanded at an average of about 100,000 per month 
during the first half of this year, a pace insufficient to 
reduce the unemployment rate materially. In all likelihood, a 
significant amount of time will be required to restore the 
nearly 8\1/2\ million jobs that were lost over 2008 and 2009. 
Moreover, nearly half of the unemployed have been out of work 
for longer than 6 months. Long-term unemployment not only 
imposes exceptional near-term hardships on workers and their 
families, it also erodes skills and may have long-lasting 
effects on workers' employment and earnings prospects.
    In the business sector, investment in equipment and 
software appears to have increased rapidly in the first half of 
the year, in part reflecting capital outlays that had been 
deferred during the downturn and the need of many businesses to 
replace aging equipment. In contrast, spending on 
nonresidential structures--weighed down by high vacancy rates 
and tight credit--has continued to contract, though some 
indicators suggest that the rate of decline may be slowing. 
Both U.S. exports and U.S. imports have been expanding, 
reflecting growth in the global economy and the recovery of 
world trade. Stronger exports have in turn helped foster growth 
in the U.S. manufacturing sector.
    Inflation has remained low. The price index for personal 
consumption expenditures appears to have risen at an annual 
rate of less than 1 percent in the first half of the year. 
Although overall inflation has fluctuated, partly reflecting 
changes in energy prices, by a number of measures underlying 
inflation has trended down over the past 2 years. The slack in 
labor and product markets has damped wage and price pressures, 
and rapid increases in productivity have further reduced 
producers' unit labor costs.
    My colleagues on the Federal Open Market Committee and I 
expect continued moderate growth, a gradual decline in the 
unemployment rate, and subdued inflation over the next several 
years. In conjunction with the June FOMC meeting, Board members 
and reserve bank presidents prepared forecasts of economic 
growth, unemployment, and inflation for the years 2010 through 
2012 and over the longer run. The forecasts are qualitatively 
similar to those we released in February and in May, although 
progress in reducing unemployment is now expected to be 
somewhat slower than we previously projected, and near-term 
inflation now looks likely to be a little lower. Most FOMC 
participants expect real GDP growth of 3 to 3\1/2\ percent in 
2010, and roughly 3\1/2\ to 4\1/2\ percent in 2011 and 2012. 
The unemployment rate is expected to decline to between 7 and 
7\1/2\ percent by the end of 2012. Most participants viewed 
uncertainty about the outlook for growth and unemployment as 
greater than normal, and the majority saw the risks to growth 
as weighted to the downside. Most participants projected that 
inflation will average only about 1 percent in 2010 and that it 
will remain low during 2011 and 2012, with the risks to the 
inflation outlook roughly balanced.
    One factor underlying the Committee's somewhat weaker 
outlook is that financial conditions--though much improved 
since the depth of the financial crisis--have become less 
supportive of growth in recent months. Notably, concerns about 
the ability of Greece and a number of other euro-area countries 
to manage their sizable budget deficits and high levels of 
public debt spurred a broad-based withdrawal from risk taking 
in global financial markets in the spring, resulting in lower 
stock prices and wider risk spreads in the United States. In 
response to these fiscal pressures, European leaders put in 
place a number of strong measures, including an assistance 
package for Greece and 500 billion euros of funding to backstop 
the near-term financing needs of euro-area countries. To help 
ease strains in U.S. dollar funding markets, the Federal 
Reserve reestablished temporary dollar liquidity swap lines 
with the ECB and several other major central banks. To date, 
drawing under the swap lines has been limited, but we believe 
that the existence of these lines has increased confidence in 
dollar funding markets, helping to maintain credit availability 
in our own financial system.
    Like financial conditions generally, the state of the U.S. 
banking system has also improved significantly since the worst 
of the crisis. Loss rates on most types of loans seem to be 
peaking, and in the aggregate, bank capital ratios have risen 
to new highs. However, many banks continue to have a large 
volume of troubled loans on their books, and bank lending 
standards remain tight. With credit demand weak and with banks 
writing down problem credits, bank loans outstanding have 
continued to contract. Small businesses, which depend 
importantly on bank credit, have been particularly hard hit. At 
the Federal Reserve, we have been working to facilitate the 
flow of funds to creditworthy small businesses. Along with the 
other supervisory agencies, we have issued guidance to banks 
and examiners emphasizing that lenders should do all they can 
to meet the needs of creditworthy borrowers, including small 
businesses. We also have conducted extensive training programs 
for our bank examiners, with the message that lending to viable 
small businesses is good for the safety and soundness of our 
banking system as well as for our economy. We continue to seek 
feedback from both banks and potential borrowers about credit 
conditions. For example, over the past 6 months we have 
convened more than 40 meetings around the country of lenders, 
small business representatives, bank examiners, Government 
officials, and other stakeholders to exchange ideas about the 
challenges faced by small businesses, particularly in obtaining 
credit. A capstone conference on addressing the credit needs of 
small businesses was held at the Board of Governors in 
Washington last week. This testimony includes an addendum that 
summarizes the findings of this effort and possible next steps.
    The Federal Reserve's response to the financial crisis and 
the recession has included several components. First, in 
response to the periods of intense illiquidity and dysfunction 
in financial markets that characterized the crisis, the Federal 
Reserve undertook a range of measures and set up emergency 
programs designed to provide liquidity to financial 
institutions and markets in the form of fully secured, mostly 
short-term loans. Over time, these programs helped to stem the 
panic and to restore normal functioning in a number of key 
financial markets, supporting the flow of credit to the 
economy. As financial markets stabilized, the Federal Reserve 
shut down most of these programs during the first half of this 
year and took steps to normalize the terms on which it lends to 
depository institutions. The only such programs currently open 
to provide new liquidity are the recently reestablished dollar 
liquidity swap lines with major central banks that I noted 
earlier. Importantly, our broad-based programs achieved their 
intended purposes with no loss to the taxpayers. All of the 
loans extended through the multiborrower facilities that have 
come due have been repaid in full, with interest. In addition, 
the Board does not expect the Federal Reserve to incur a net 
loss on any of the secured loans provided during the crisis to 
help prevent the disorderly failure of systemically significant 
financial institutions.
    A second major component of the Federal Reserve's response 
to the financial crisis and recession has involved both 
standard and less conventional forms of monetary policy. Over 
the course of the crisis, the FOMC aggressively reduced its 
target for the Federal funds rate to a range of 0 to \1/4\ 
percent, which has been maintained since the end of 2008. And 
as indicated in the statement released after the June meeting, 
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.
    In addition to the very low Federal funds rate, the FOMC 
has provided monetary policy stimulus through large-scale 
purchases of longer-term Treasury debt, Federal agency debt, 
and agency mortgage-backed securities, or MBS. A range of 
evidence suggests that these purchases helped to improve 
conditions in mortgage markets and other private credit markets 
and put downward pressure on longer-term private borrowing 
rates and spreads.
    Compared with the period just before the financial crisis, 
the System's portfolio of domestic securities has increased 
from about $800 billion to $2 trillion and has shifted from 
consisting of 100 percent Treasury securities to having almost 
two-thirds of its investments in agency-related securities. In 
addition, the average maturity of the Treasury portfolio has 
nearly doubled, from 3\1/2\ years to almost 7 years. The FOMC 
plans to return the System's portfolio to a more normal size 
and composition over the longer term, and the Committee has 
been discussing alternative approaches to accomplishing that 
objective.
    One approach is for the committee to adjust its 
reinvestment policy--that is, its policy for handling 
repayments of principal on the securities--to gradually 
normalize the portfolio over time. Currently, repayments of 
principal from agency debt and MBS are not being reinvested, 
allowing the holdings of these securities to run off as the 
repayments are received. By contrast, the proceeds from 
maturing Treasury securities are being reinvested in new issues 
of Treasury securities with similar maturities. At some point, 
the committee may want to shift its reinvestment of the 
proceeds from maturing Treasury securities to shorter-term 
issues so as to gradually reduce the average maturity of our 
Treasury holdings toward pre-crisis levels, while leaving the 
aggregate value of those holdings unchanged. At this juncture, 
however, no decision to change reinvestment policy has been 
made.
    A second way to normalize the size and composition of the 
Federal Reserve's securities portfolio would be to sell some 
holdings of agency debt and MBS. Selling agency securities, 
rather than simply letting them run off, would shrink the 
portfolio and return it to a composition of all Treasury 
securities more quickly. FOMC participants broadly agree that 
sales of agency-related securities should eventually be used as 
part of the strategy to normalize the portfolio. Such sales 
will be implemented in accordance with a framework communicated 
well in advance and will be conducted at a gradual pace. 
Because changes in the size and composition of the portfolio 
could affect financial conditions, however, any decisions 
regarding the commencement or pace of asset sales will be made 
in light of the committee's evaluation of the outlook for 
employment and inflation.
    As I noted earlier, the FOMC continues to anticipate that 
economic conditions are likely to warrant exceptionally low 
levels of the Federal funds rate for an extended period. At 
some point, however, the committee will need to begin to remove 
monetary policy accommodation to prevent the buildup of 
inflationary pressures. When that time comes, the Federal 
Reserve will act to increase short-term interest rates by 
raising the interest rate it pays on reserve balances that 
depository institutions hold at Federal reserve banks. To 
tighten the linkage between the interest rate paid on reserves 
and other short-term market interest rates, the Federal Reserve 
may also drain reserves from the banking system. Two tools for 
draining reserves from the system are being developed and 
tested and will be ready when needed. First, the Federal 
Reserve is putting in place the capacity to conduct large 
reverse repurchase agreements with an expanded set of 
counterparties. Second, the Federal Reserve has tested a term 
deposit facility, under which instruments similar to the 
certificates of deposit could be auctioned to depository 
institutions.
    Of course, even as the Federal Reserve continues prudent 
planning for the ultimate withdrawal of extraordinary monetary 
policy accommodation, we also recognize that the economic 
outlook remains unusually uncertain. We will continue to 
carefully assess ongoing financial and economic developments, 
and we remain prepared to take further policy actions as needed 
to foster a return to full utilization of our Nation's 
productive potential in a context of price stability.
    Last week, the Congress passed landmark legislation to 
reform the financial system and financial regulation, and the 
President signed the bill into law this morning. That 
legislation represents significant progress toward reducing the 
likelihood of future financial crises and strengthening the 
capacity of financial regulators to respond to risks that may 
emerge. Importantly, the legislation encourages an approach to 
supervision designed to foster the stability of the financial 
system as a whole as well as the safety and soundness of 
individual institutions. Within the Federal Reserve, we have 
already taken steps to strengthen our analysis and supervision 
of the financial system and systemically important financial 
firms in ways consistent with the new legislation. In 
particular, making full use of the Federal Reserve's broad 
expertise in economics, financial markets, payment systems, and 
bank supervision, we have significantly changed our supervisory 
framework to improve our consolidated supervision of large, 
complex bank holding companies, and we are enhancing the tools 
we use to monitor the financial sector and to identify 
potential systemic risks. In addition, the briefings prepared 
for meetings of the FOMC are now providing increased coverage 
and analysis of potential risks to the financial system, thus 
supporting the Federal Reserve's ability to make effective 
monetary policy and to enhance financial stability.
    Much work remains to be done, both to implement through 
regulation the extensive provisions of the new legislation and 
to develop the macroprudential approach called for by the 
Congress. However, I believe that the legislation, together 
with stronger regulatory standards for bank capital and 
liquidity now being developed, will place our financial system 
on a sounder foundation and minimize the risk of a repetition 
of the devastating events of the past 3 years.
    Thank you, Mr. Chairman. I would be pleased to respond to 
your questions.
    Chairman Dodd. Thank you very much, and what I will do is I 
will ask the Clerk to--let us try 7 minutes a round. Again, I 
won't be banging down the gavel too hard, but if people try and 
keep them in that timeframe, it will be helpful since we have 
got a pretty good turnout, if we can.
    Let me begin by raising the issue--Senator Shelby made note 
of the reference to the recent crisis in Europe. Let me start 
out there, if I can. As the European Union announced its 
financial stabilization program in May, you briefed us, in 
fact, here on the Committee on the Fed's decision to 
temporarily reopen the dollar swap lines with the ECB and other 
foreign central banks to support liquidity in the dollar 
funding markets. Clearly, the Fed identified a need to protect 
the American economy from events in Europe.
    With continued downgrades of European sovereigns--I noticed 
Ireland, just the other day, they downgraded a bit--European 
bank stress test results expected this week, and again, there 
has been a lot written about that, how successful they may be, 
and the uncertainty about future economic growth, as well, what 
challenges lie ahead, in your view, for the efforts you and 
your counterparts in Europe have made to stabilize the 
financial system?
    Mr. Bernanke. Well, Senator, as I mentioned, concerns about 
the European situation created some problems in financial 
markets this spring, which spilled over into our own financial 
markets, as well. The Europeans have been quite aggressive in 
addressing these problems. As you know, they, together with the 
IMF, have provided a financial program for Greece and they have 
collectively developed a stabilization fund of 500 billion 
Euros, together with additional funds potentially from the IMF, 
to be used to ensure that countries under fiscal stress will be 
able to make their payments and to finance their governments. 
And indeed, in the last few weeks, we have seen some of the 
troubled governments being able to go back to the market, which 
I think is encouraging.
    The Federal Reserve's liquidity swap lines were a 
relatively minor part of that effort, but I think they have 
provided some assurance that dollar funding markets will be 
sufficiently liquid and have reduced the risks to our own 
financial system.
    The other thing that the Europeans are doing is trying to 
duplicate the success of the American bank stress tests of a 
little more than a year ago by conducting a set of stress tests 
whose results are supposed to be released later this week. Of 
course, it remains to be seen how effective those stress tests 
are, but it is clear that the Europeans are very focused and 
very committed to addressing these issues, and my sense is that 
the financial market concern about European problems has 
diminished to some extent recently, which is, in turn helpful 
to our economy.
    But we will at the Federal Reserve continue to be in close 
contact with our colleagues in Europe. I am going to Europe for 
this weekend. And we will continue to monitor developments and 
their potential impact to the U.S. economy.
    Chairman Dodd. Well, I appreciate that, and I think the 
committee would probably as a general matter like to be kept 
abreast and informed as to your observations regarding their 
progress. Obviously, a lot of difficulty. While they share 
common currencies and so forth, the differences in fiscal 
policies in the various countries make their ability to resolve 
these in some sort of united fashion even more difficult, it 
seems. But I hope your assessment is correct.
    Let me, if I can, raise an issue that has been--and it is 
not your job, obviously, to get into policy debates here on 
specific legislative matters, so I am not going to try and pin 
you down on that. But we are going through the debate here now. 
Obviously, we have got slow growth, as you pointed out, high 
unemployment, low interest rates, low inflation. And again, 
obviously, we have got deficits that are mounting. And so the 
debate back and forth is to where is the balance? How do we 
strike here, an austerity program or do we try and stimulate 
some economic growth in the country at the same time and how do 
we do that.
    You are a student of the Depression era, and there are many 
who have written about the failure of the New Deal 
administration after the first couple of years to not sustain a 
policy of economic growth, in fact, follow an austerity path, 
again, using that language. And those who have argued that 
because they did that, they delayed, of course, the second or 
more--or delayed recovery during that period of time.
    Give us your take on this as a general matter. And again, I 
am not asking you to engage in the debate about specific budget 
requests and the like. But stepping back sort of with a macro 
approach here, what do you advise us in the legislative branch 
as to how to approach this debate, because obviously it is 
tearing us a bit apart up here and we need to strike some 
balance in all of this. Deficit reduction is clearly a goal we 
have got to focus on, but also, simultaneously, we have got to 
try and stimulate economic growth in the country which requires 
some government activity, as well.
    Mr. Bernanke. Mr. Chairman, as you know, this is very 
controversial and there has been a lot of debate on both sides. 
On the one hand, and I will come back to a kind of 
recommendation, but on the one hand, you have folks who are 
focusing on the need for government support in the current 
economic environment. Obviously, in the United States and in 
many other countries, we have a great deal of excess capacity. 
Private spending is weak. And so the argument is that 
additional fiscal support might be helpful to the economy.
    Chairman Dodd. Right.
    Mr. Bernanke. On the other side, you have people who are 
concerned about the longer-term deficit situation, are worried 
that financial markets might respond in an adverse way or 
confidence might respond in an adverse way to signals that any 
government is not committed to long-term fiscal sustainability.
    So there is some truth to both of those arguments. I think 
the right way to combine them is to think about the entire 
trajectory of fiscal policy. I do believe that at the current 
moment, that the large deficits, as unattractive as they are, 
are important for supporting economic activity and they were 
important also in restoring financial stability, and so I think 
they were justified in that respect and I would be reluctant to 
withdraw that support too precipitously in the near term.
    At the same time, to maintain confidence and keep interest 
rates low, it is very important that we have a strong and 
credible plan for reducing deficits over the next few years.
    So if we think of this instead of either/or and think of it 
as a combination and think about the trajectory, the best 
approach, in my view, is to maintain some fiscal support for 
the economy in the near term, but to combine that with serious 
attention to addressing what are very significant fiscal issues 
for the United States in the medium term.
    Chairman Dodd. Let me pick up on that, because again, you 
and I have chatted over the years and I have been very 
impressed with some of your writings about the long-term 
effects of unemployment. We have a tendency to see these 
matters where we have got a certain level of unemployment. Then 
things happen and we get people back to work. That is obviously 
the goal.
    But talk to us about the long-term effects of unemployment. 
What worries you about that, in a brief comment, if you would?
    Mr. Bernanke. Well, this is part of the reason why I am 
concerned about the current situation and why I made reference 
in my remarks to the fact that, currently, about half of the 
unemployed have been unemployed for 6 months or more. So in 
terms of long-term unemployment, this is the worst labor 
market, the worst episode since the Great Depression.
    Of course, long-term unemployment is very stressful for the 
unemployed and their families, being without income or reduced 
income for such a long period of time. But even from the 
perspective of economic growth and stability, as we have seen 
in other countries, people who are unemployed for a long period 
of time often see their skills atrophy or see their skills 
become irrelevant to the new economy or the way the economy is 
developing, or they may become demoralized and may become 
separated from the labor market. Indeed, long-term unemployment 
sometimes becomes permanent unemployment.
    So not only for the sake of the unemployed and for the 
short-term strength of the economy, but also for our long-term 
viability and international competitiveness, I think we need to 
be very seriously concerned about the implications of long-term 
unemployment for skills, for labor force attachment, for long-
term earnings and employment opportunities.
    Chairman Dodd. Well, I appreciate that, and obviously that 
was the point I was trying to make here. Your point is that 
there is enough empirical data on this and other examples that 
have occurred so that is not mere speculation about what can 
happen in terms of job skill levels and the ability of people 
then to recover and get back on their feet, not just 
individually, but overall the economy of a country is affected 
by it.
    Mr. Bernanke. There is a good bit of research on this 
question.
    Chairman Dodd. I thank you for that.
    Let me turn to Senator Shelby.
    Senator Shelby. Mr. Chairman, we all, I think, agree that 
long-term unemployment problems is a cancer dealing with our 
economy and people's operations. On the other hand, a spiraling 
deficit and accumulated debt like we are going through now is 
also a real problem. And the question is, how do we balance 
that and how much time do we have, isn't it?
    Mr. Bernanke. Well, Senator, as I responded to the 
Chairman, I absolutely agree that this is a concern, that if 
there is a loss of confidence in the financial markets that the 
United States is committed to and will achieve long-term fiscal 
sustainability, then the implications could be bad, not only 
for our long-term growth prospects, but they could actually 
hurt the current recovery for higher interest rates or higher 
inflation expectations.
    So it is very important to demonstrate as best we can, 
given the difficulties of committing future Congresses and so 
on, but to demonstrate as best we can that we are serious about 
addressing long-term issues. And so I don't think it is either/
or. I think you really need to do both.
    Senator Shelby. But accumulating debt after debt each year 
is not good for anybody in this country, is it----
    Mr. Bernanke. I agree.
    Senator Shelby. ----short term, right?
    Mr. Bernanke. If the debt continues to accumulate and 
becomes unsustainable, as the Congressional Budget Office 
believes our current policies are, then the only way that can 
end is through a crisis or some other very bad outcome.
    Senator Shelby. Do you, as Chairman of the Fed, do you 
believe that our current continuing to have these big deficits 
adding to our debt is unsustainable?
    Mr. Bernanke. I do, and I think that view is widely shared.
    Senator Shelby. Thank you. Mr. Chairman, the minutes of the 
June FOMC, the Federal Open Markets Committee meeting, stated, 
and I will quote, ``The committee would need to consider 
whether further policy stimulus might become appropriate if the 
outlook were to worsen appreciably.''
    Aside from taking the Federal funds rate and the interest 
rate paid on reserves to zero, it is not clear to me what 
further policy stimulus would mean. If further stimulus were to 
involve more asset purchases that you alluded to by the Fed, 
would the Fed buy Treasuries or would they try to channel 
credit to specific segments of the financial markets, such as 
housing or perhaps even municipal debt?
    Mr. Bernanke. Senator, I think it is important to preface 
the answer by saying that monetary policy is currently very 
stimulative, as I am sure you are aware.
    Senator Shelby. Yes.
    Mr. Bernanke. We have brought interest rates down close to 
zero. We have had a number of programs to stabilize financial 
markets. We have language which says that we plan to keep rates 
low for an extended period. And we have purchased more than a 
trillion dollars in securities. So certainly no one can accuse 
the Fed of not having been aggressive in trying to support the 
recovery.
    That being said, if the recovery seems to be faltering, 
then we will at least need to review our options, and we have 
not fully done that review and we need to think about 
possibilities. But broadly speaking, there are a number of 
things that we could consider and look at.
    One would be further changes or modifications of our 
language or our framework describing how we intend to change 
interest rates over time, giving more information about that. 
That is certainly one approach.
    We could lower the interest rate we pay on reserves, which 
is currently one-fourth of 1 percent.
    The third class of things, though, has to do with changes 
in our balance sheet, and that would involve either not letting 
securities run off, as they are currently running off, or even 
making additional purchases.
    We have not come to the point where we can tell you 
precisely what the leading options are. Clearly, each of these 
options has got drawbacks, potential costs. So we are going to 
continue to monitor the economy closely and continue to 
evaluate the alternatives that we have, recognizing that policy 
is already quite stimulative.
    Senator Shelby. Some people believe that the Fed is running 
out of options. From what you just said, you believe you still 
have some options, depending on the circumstances.
    Mr. Bernanke. I think we do still have options, but they 
are not going to be the conventional options and so we need to 
look at them carefully and make sure we are comfortable with 
any step that we take.
    Senator Shelby. I want to get into the area of small 
business lending. Mr. Chairman, I hear reports of a credit 
crunch for small businesses and calls by other people to 
initiate more government programs to jump start lending in this 
area. I have two questions related to small business credit.
    First, is there some market failure or regulatory failure 
inhibiting the flow of small business credit which requires 
even more government intervention?
    Second, is there any slow down in small business credit 
because of weaker demand, because of a deterioration in 
financial conditions of small businesses and values of the 
collateral that they hold, or because of regulators somehow 
inhibiting or preventing good loans from being made? In other 
words, do we know the definitive reason for the slow down in 
credit flow to small businesses and what is your take?
    Mr. Bernanke. Senator, we have done a great deal of work on 
this and the addendum to my remarks gives you some of the 
findings of our meetings around the country on this issue. 
Certainly, a significant part of the reduction in lending to 
small business is the result either of lower demand, because 
firms don't want to expand, they don't have the final demand to 
grow----
    Senator Shelby. Uncertainty, perhaps?
    Mr. Bernanke. I am sorry?
    Senator Shelby. Uncertainty in the economy?
    Mr. Bernanke. Uncertainty and other factors. In other 
cases, the firm might like to expand, but its collateral value 
has declined and it is financially weaker and it is no longer 
viewed as being creditworthy at the current credit standards. 
So there are certainly a number of reasons why the demand for 
credit or the attractiveness of some borrowers has declined in 
this recession.
    At the same time, we want to be sure that every 
creditworthy small business or borrower is able to obtain 
credit, and while there are many issues to look at as 
regulators, one that we are particularly concerned about is 
that bank regulators might somehow be putting the thumb on the 
scale on the wrong side and being excessively cautious about 
not letting banks issue what are even marginally risky loans 
and not taking into account the importance to our economy that 
creditworthy borrowers receive credit.
    And so much of our effort has been focused on instructing 
and training our examiners to take a balanced approach, where 
they both are taking appropriate caution, but also making sure 
that creditworthy borrowers can get credit.
    Senator Shelby. My time is running and has run. GSE debt 
reform--do you believe that the debt of Fannie and Freddie is 
backed by the full faith and credit of the United States of 
America?
    Mr. Bernanke. Well, not technically or legally, but, of 
course, the----
    Senator Shelby. Do you believe----
    Mr. Bernanke. Legally, I don't know what the legal status 
is. I don't think it has been given that status by the 
Congress. But, of course----
    Senator Shelby. Do you believe the market has given that 
status?
    Mr. Bernanke. The market, I think, takes appropriate 
comfort from the fact that there is a considerable amount of 
appropriated funds backing up those two companies.
    Senator Shelby. What risk does the Fed face in holding GSE 
debt?
    Mr. Bernanke. Well, for exactly the reason you just raised, 
that the Treasury is providing backstop support for the 
mortgages, we are taking essentially no credit risk. There is 
some interest rate risk, if interest rates were to rise 
sharply. But on the other side of that, with our very low cost 
of funding, we have actually been earning a fairly high income 
from our holdings and have been remitting that to the Treasury.
    Senator Shelby. Last, do you believe that it is important 
for Congress to act quickly to reform the GSEs and provide 
certainty and clarity to our Nation's housing policies?
    Mr. Bernanke. And I have said so before and I agree with 
that, Senator.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much.
    Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman.
    Thank you, Chairman Bernanke. As you pointed out, the 
President signed the financial reform bill this morning and 
there are many that thought we could not do it, get it passed. 
But it is a tribute to Senator Dodd's leadership, actually, the 
collaboration of everyone on this committee, including many of 
my Republican colleagues. People thought we couldn't do it, and 
I think there is a sizable population out there that believes 
that the regulators might undo much of what we have done.
    So could you give us your sense of how procedurally and 
substantively you and your fellow regulators will prevent or at 
least ensure that the regulated community doesn't have an 
inappropriate influence on the rules and regulations that are 
going to be developed?
    Mr. Bernanke. Well, speaking for myself and the Federal 
Reserve, we think that the framework in this bill is very 
constructive. It addresses many of the gaps and problems that 
we saw in the crisis, and for our part, we intend to write 
rules that will implement the intent of Congress and that will 
be sufficiently tough to ensure that the risk of another crisis 
is very low.
    A lot of the effectiveness of this bill, of course, depends 
on the implementation, not just the rule writing, but also the 
actual supervision and execution of those rules, and we are 
taking this very seriously. We are restructuring our entire 
supervisory framework, both intellectually and in management 
terms, to make sure that we are able to address risks to the 
broader financial system as this bill envisions and that we are 
able to support the FDIC in its wind-down function and the CFTC 
and SEC in their oversight of central counterparties, et 
cetera. So we are very committed to making this work and we 
think it gives us the tools that will allow us to do that.
    Senator Reed. Just to follow up, I think you understand 
that there is a very--the high degree of skepticism. And you go 
into this, I presume, acknowledging that in the public, so that 
your efforts have to be transparent and not only for the 
substance, but also the appearance of the deliberation is not 
influenced by anyone, is that a fair----
    Mr. Bernanke. That is absolutely right. I would add that we 
are also working with our international colleagues on capital 
liquidity standards, which I think will be an additional 
strength of the overall reform package.
    Senator Reed. Mr. Chairman, I have been made aware, and 
others have, too, that there is roughly $2 trillion on the 
balance sheets of American companies that is not being deployed 
in new product research, investment, expansion of jobs. Can you 
give us an indication of why that is happening? And also, it 
would seem to me that this recovery is going to either be led 
by very aggressive Federal policy to support employment or 
private policy, and the private money is there but it is not 
happening.
    Mr. Bernanke. Well, the larger corporations, in particular, 
have had a significant rebound in their profits. They have been 
able to refinance their debt at quite favorable terms, given 
the low interest rates in corporate bond markets. And, of 
course, they have been reluctant to make large capital 
investments in an environment where they have a lot of excess 
capacity. And so for all those reasons and also for reasons of 
caution, those cash balances have built up.
    My presumption is that as uncertainty declines, as firms 
become more confident in the recovery, that they will deploy 
those funds and that will be an important source of growth for 
our economy.
    Senator Reed. Mr. Chairman, let me talk about another area 
which could be and in some cases already is a potential drag on 
the economy, and that is State and local governments who are 
being faced with significant budget challenges. Are you 
concerned that they might, indeed, collectively counteract what 
you and what we are trying to do to move the economy forward?
    Mr. Bernanke. Well, as you know, the Federal Government has 
already provided a great deal of support to the State and local 
governments. Notwithstanding that, they are still in a cutting 
mode and seem likely to cut several hundred thousand jobs going 
forward. So that is a drag on the economy, no question about 
it.
    I suppose that one small piece of good news is that 
municipal bond markets are functioning reasonably well and 
rates are pretty low, so that most States are able to obtain 
funding if they need it. But it certainly is one of the factors 
which is reducing the recovery speed that we are experiencing.
    Senator Reed. The final sort of area of concern is you have 
spoken about and my colleagues have spoken about the need to 
address the deficit and the need to do things that will not 
contribute to the long-term deficit. Is it useful to think 
about those policies that add to the structural deficit versus 
those policies, such as unemployment compensation, that does 
not add to the structural deficit, that it is typically 
emergency spending that will be made up as the economy 
recovers, employment recovers? And in that regard, proposals to 
once again extend the Bush tax cuts would, I think, add to the 
structural deficit, since they are unconditional, but temporary 
assistance to States, temporary assistance to workers would not 
add to that structural deficit. Is that a fair way to look at 
it?
    Mr. Bernanke. I think it is useful to distinguish cyclical 
and structural deficits and it is consistent with what I was 
saying before, is that right now, some fiscal support for the 
economy is probably a constructive thing, whereas over the 
medium term, we need to reduce our fiscal deficits, which is 
consistent with lowering the structural component of our 
deficits. But I would urge you not just to leave the structural 
deficit alone. I mean, it is too high and anything we can do to 
reduce the structural deficit, not just leave it alone, would 
be positive for the markets and would make it easier for the 
markets to accept any shorter-term actions you might want to 
take.
    Senator Reed. The unconditional extension of the Bush tax 
cuts would add further to a structural deficit that is much too 
high at the moment, is that your opinion?
    Mr. Bernanke. Well, the CBO would do that holding 
everything else constant. But I don't want to be interpreted as 
recommending one policy or another policy. As you know, I am 
not----
    Senator Reed. Your colleague was not that reticent.
    Mr. Bernanke. Well----
    Senator Reed. Or your predecessor.
    Mr. Bernanke. I don't think it is really my place to tell 
Congress which specific tax and spending policies to choose. I 
prefer to address the broader trajectory of fiscal stimulus.
    Senator Reed. Well, the trajectory would be made better or 
worse if those provisions were extended without condition?
    Mr. Bernanke. Well, if no other changes were made, it would 
increase the cyclical, or maintain the cyclical and also 
increase the structural. Now, of course, there is always the 
possibility of taking other measures to offset whatever you do 
on any particular program.
    Senator Reed. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator.
    Senator Bunning.
    Senator Bunning. Thank you, Mr. Chairman.
    Thank you, Chairman Bernanke, for being here. There are so 
many things I would like to ask you.
    First of all, the job of the Federal Reserve is monetary 
policy. I want to clear that up.
    Mr. Bernanke. That is part of our job, but we also have 
financial stability responsibilities, in my view.
    Senator Bunning. But the main thrust of the Federal Reserve 
is to conduct the monetary policy of the United States of 
America.
    Mr. Bernanke. I don't think it is the exclusive----
    Senator Bunning. I didn't say it was exclusive.
    Mr. Bernanke. It is very important and unique to the 
Federal Reserve to do monetary policy.
    Senator Bunning. If I got into monetary policy, you would 
get mad, as a Congressman.
    Mr. Bernanke. I think it is important for the Fed to have 
independence in making monetary policy.
    Senator Bunning. OK. I just want to reemphasize something 
that my Ranking Member said. Several news stories in the last 
few weeks, senior Federal Reserve officials, presumably you or 
someone close to you, have explained three actions the Fed 
could take to boost the economy if conditions get worse, and 
you have talked about them, lowering the interest reserve rates 
to zero, not \1/4\, but zero; extending the period of time for 
a near-zero Fed fund rate; and using proceeds from previous 
asset purchases to buy more mortgage-backed securities. 
However, many commentators and even some officials at the Fed 
doubt that these actions would have much of an impact.
    Do you share their concerns, and what are we going to do if 
these options do not work? Are you out of bullets?
    Mr. Bernanke. Well, I don't think so. We need to continue 
to evaluate those options. As I said, we are not prepared to 
take any specific steps in the near term, particularly since we 
are still also evaluating the recovery and the strength of the 
recovery. But I do think that there is some potential for some 
of those steps to be effective and we will continue to look at 
them, recognizing your concerns. You raised the issue of credit 
allocation, for example, with the MBS, and a number of members 
of the FOMC agree with your concern.
    Senator Bunning. In evaluating some monetary policy in your 
discussion of your own testimony, you said that you were 
looking for 3 to 3\1/2\ in 2011 for growth and 4 to 4\1/2\ in 
2012. Is that accurate?
    Mr. Bernanke. I don't think those were quite the numbers I 
had, but----
    Senator Bunning. Oh, I am sorry----
    Mr. Bernanke. ----they are in the testimony. I think it is 
three-and-a-half----
    Senator Bunning. I wrote them down.
    Mr. Bernanke. Three-and-a-half to four-and-a-half, I 
believe was the number.
    Senator Bunning. OK, that is close. Over the 2 years?
    Mr. Bernanke. For 2011 and 2012, yes.
    Senator Bunning. Thank you. OK. And 7.5 percent 
unemployment by the year 2012?
    Mr. Bernanke. By the end of 2012, 7.1.
    Senator Bunning. Seven-point-one, OK. You know, in this 
regulatory bill, we have given the Fed a lot more power. You 
know, in 1994, we gave the Fed a lot of power. We gave them 
total control over bank mortgages and mortgage brokers, 1994 
law we passed, this Congress. And, you know, for 14 years, they 
didn't write a regulation. Not one. Not until you did after 
your second year in office.
    Now, if we give you all that power in this new regulatory 
bill that has just passed and you sit on your hands for 14 
years, it isn't going to do us any good, is it?
    Mr. Bernanke. You are absolutely right.
    Senator Bunning. Well, I am really concerned because we are 
at approximately 90 bank failures this year in the United 
States of America--90. I don't know what it is going to--what 
August, September, October, November, and December will bring. 
But the FDIC has to resolve those banks or the Comptroller of 
the Currency, or whichever is the regulator of that bank.
    Now we have handed you a job, in my mind, that is damn near 
impossible. You are going to have to pick and choose who is too 
big to fail. You and a group of so many people, but you 
particularly. And it is a subjective view. It is not--it 
doesn't say, these are the categories. It says that you should 
decide who is too big to fail. Is that accurate? Do you accept 
that as an accurate review of what is in the----
    Mr. Bernanke. No, Senator. What we have to determine is 
which firms are systemically critical, but they will be subject 
to this resolution regime, which means that they will fail and 
the creditors will lose money.
    Senator Bunning. But it is subjective. It is not objective.
    Mr. Bernanke. I think it will be important for us to 
develop as many criteria, clear criteria as we possibly can.
    Senator Bunning. Oh, I think----
    Mr. Bernanke. Obviously, it will be partly subjective, yes.
    Senator Bunning. OK. You know, we are $13 trillion going to 
$14 trillion in our debt. And if you count agency debt--that is 
public debt. If you count agency debt, just in Social Security, 
we are at $1 trillion. So if we add that to the $13 trillion, 
agency debt plus public, that is $14 trillion already. This 
year, we are not going to have a $14 trillion GDP, not unless 
we have an unbelievable recovery in the second half of this 
year. Isn't that pretty close to where Greece was?
    Mr. Bernanke. Well, I think that, first of all, adding the 
GSE debt is not entirely appropriate, because on the other side 
of the balance sheet are assets, mortgages, that are worth 
something.
    Senator Bunning. But don't we have to make good those trust 
fund mortgages like Social Security? Don't we, as a government, 
have to make good on those pieces of paper that are up in West 
Virginia?
    Mr. Bernanke. But if we have 5 or 10 percent losses, we 
will still have 90 or 95 percent assets there. So it is not as 
if we had borrowed the $5 trillion of the outstanding MBS and 
had no assets to show for it.
    Senator Bunning. But we did spend the money.
    Mr. Bernanke. We spent several hundred billion, but not 
five trillion.
    Senator Bunning. Well, as the Chairman of the Social 
Security Subcommittee, when I was there, they were spending 
every penny they got from the Social Security Administration 
for other purposes. That means that we have to make up the 
difference.
    I just am worried where we are heading and I am worried 
about the tools that you have to counter where we are heading. 
I surely don't want us to not recover fully from this 
recession, because that is the--I mean, lack of jobs is the 
secret. We have got to create jobs. Small business creates 
jobs, and if this Congress doesn't act, we are not going to 
create those jobs. So I wish you good well.
    Mr. Bernanke. Thank you.
    Senator Bunning. Good luck.
    Chairman Dodd. Thank you, Senator. Let me just say here, if 
we were in the status quo and had not passed this bill and the 
tools that existed 2 years ago, we would be a lot more 
vulnerable today than we are without this, so I thank you.
    Senator Bayh.
    Senator Bayh. Mr. Chairman, this may be my last opportunity 
to interact with you in this capacity, and I just want to take 
this moment to thank you for your service to our country once 
again and to say it has been a pleasure working with you on 
some of these issues.
    My first question has to--there have been a lot of comments 
here about our budget deficits and debt, which is accurately 
described, as you pointed out, as unsustainable. I would like 
to ask about another unsustainable disequilibrium, and that is 
our current account deficit and the corresponding current 
account surpluses in China and other parts of the developing 
world.
    Many observers believe that it was this disequilibrium that 
gave rise to a glut of global capital that undergirded the 
asset bubble that led to some of the problems that we have 
seen. There were some signs it was beginning to be self-
correcting. Savings rates in our country were going up. 
Consumption in China is rising. But the most recent data 
suggests that perhaps the current account imbalance is once 
again on the rise. So my question to you is: How concerned 
about this should we be? And given the apparent return to the 
status quo ante in terms of the gap, is this going to be self-
correcting, or do other measures need to be taken?
    Mr. Bernanke. Well, first, on the forecast, the current 
account deficit did drop from about 6 percent of GDP to about 3 
percent of GDP, and it has increased slightly, but our view is 
that in the medium term it is not going to go back to where it 
was, that we have made some progress in that respect. But to 
continue with the progress, we need to continue to have global 
adjustment, and that essentially means that surplus countries 
like China and others need to increase their reliance on 
domestic demand and, where appropriate, have flexible exchange 
rates. And the United States has to do its part, and this ties 
back to your first comment about sustainability, which is that 
in order to reduce our current account deficit, we have to 
increase our national saving. Better fiscal position is part of 
that. Higher household and business saving is part of that. So 
that is an important imperative, one that the IMF and other 
international agencies continue to focus on, and I absolutely 
agree with you that if the current account deficit were to 
return to 5 or 6 percent of GDP, that would be a very worrisome 
situation.
    Senator Bayh. Well, let us hope we can get some bipartisan 
cooperation around here in getting our fiscal house in order, 
which will help with the savings issue. Let us hope the Chinese 
will continue to move in the area of currency flexibility.
    So as you look out to the future, you think that 3 
percent--is that going to be about where it will be, do you 
think? And if so, that is--clearly not 5 or 6. Is that 
sustainable, the 3 percent rate?
    Mr. Bernanke. For the next few years. That is our estimate, 
but it is just forecast.
    Senator Bayh. OK. I just saw the monthly figures last 
month, so hopefully that does not augur a return to something 
more----
    Mr. Bernanke. We do not focus on bilateral trade deficits 
for U.S.-China. We look at the overall, and that is somewhat 
different.
    Senator Bayh. My second question has to do with the Greek 
debt crisis once again, and as you pointed out, the Europeans 
moved very aggressively and things seem to have calmed down a 
fair amount there. But I look with some alarm, even if they 
implement all these austerity measures that they are thinking 
about, and as you can see there is a fair amount of political 
turmoil around all that, it looks as if they are still going to 
be at about 130 percent or so of debt-to-GDP ratio, even after 
they have implemented all these steps. And just putting my 
political hat on, it could be pretty hard for them to go 
substantially beyond that. So that still looks like it is going 
to be pretty hard to sustain a situation like that. So I do not 
expect you to comment upon the likelihood of restructuring or 
anything like that. But you had mentioned that the whole 
episode, while it caused some disturbance, we have now kind of 
gone beyond that.
    So my question would be: In the event of an orderly 
restructuring of Greek debt at some point, I assume that it 
would also have only a marginal impact upon our own markets?
    Mr. Bernanke. Well, what I think is important is that at 
least for the next few years, the Europeans have provided 
enough funding to assure no restructuring, no default, and that 
is important because we remain vulnerable in our recovery and 
in our financial markets to the kind of stress that would 
cause. So I am encouraged by the commitment of the Europeans in 
the large amount of funding.
    The other side of their program is also to create what the 
IMF would call conditionality, which is that they are within 
European mechanisms for achieving fiscal sustainability within 
their members. So the countries that receive assistance will 
also be under a lot of pressure from their peers within the 
euro zone or within the EU to make appropriate adjustments.
    Senator Bayh. That actually leads me to my final question. 
I will make one comment I do not expect you to respond to, but 
a skeptic might look at all this and say what was really at 
work here was a choice between an eventual orderly 
restructuring or a disorderly restructuring that could have 
been very destabilizing, and so what the Europeans are 
attempting to do is to recapitalize their banks and get them in 
better shape for the eventual haircut that may lie down the 
road at some point. So that is just an observation some have 
made about what is transpiring there, and hopefully the world 
economy will be in a stronger position and be willing to absorb 
all of that if, in fact, something like that happens.
    But we had a great hearing yesterday, and I want to thank 
you for making Mr. Tarullo available. His testimony was very 
candid, very insightful, very helpful, and that was about the 
importance--since we passed our financial regulatory response 
to the crisis, the importance of global harmonization and 
convergence about standards and enforcement mechanisms and all 
that. And you mentioned the--I am sure many of the Europeans, 
particularly the Germans, wish that they had focused a little 
bit more on some of the enforcement mechanisms with regard to 
government fiscal policy at the time they had formed the common 
currency.
    And so my question to you, Chairman, my final question 
would be: How important is it to our country that we continue 
to have, you know, harmonization of standards and particularly 
that there are enforcement mechanisms in place to ensure that 
those standards are abided by most of the time? Because that is 
going to be important to, I think, avoiding a recurrence of the 
crisis at some point. And, second, there are some 
competitiveness aspects with regard to this that could affect 
American institutions?
    Mr. Bernanke. Well, it is very important. We are not going 
to have perfect harmonization because countries are in 
different situations. They have different banking systems, 
different financial systems. But we are making good progress in 
negotiating with our colleagues a strengthening of capital 
liquidity standards that will help make our banking system more 
stable in the event of another stress event, as we recently 
saw.
    We do not really have binding mechanisms to enforce the 
agreements across borders. Every country applies the Basel 
standards within its own borders according to its own 
decisions. But we do work closely together and apply peer 
pressure and other mechanisms to try to keep the standards very 
similar, and, indeed, our very key objective over the next few 
months is to come up with an international agreement on capital 
liquidity standards that will both be tough--and the United 
States is leading the way in looking for a very tough set of 
rules--but also that will be acceptable and agreed upon across 
the major countries.
    Senator Bayh. Capital liquidity standards, resolution 
protocols, how we handle derivatives, all those kinds of 
things, it is just important that we harmonize as much as 
possible. Otherwise, we could see a repetition of the Greek 
phenomenon, not in the sovereign debt situation but when it 
comes to financial regulations. So we have taken some major 
steps here, and if we are going to really get the full fruits 
of that, it is important we try and get as much of the rest of 
the world to go along, and I thank you for your efforts in that 
regard. And, again, thank you for making Mr. Tarullo available, 
and thank you for your service to our country.
    Mr. Bernanke. Thank you.
    Chairman Dodd. Thank you, Senator, very much.
    Just on that point, we had regulatory arbitrage. You could 
end up with sovereign arbitrage in a sense if we do not try and 
harmonize those rules. That will be an important question.
    Senator Corker.
    Senator Corker. Thank you, Mr. Chairman. I was thinking, 
the last time the Federal Reserve Chairman was in and today, 
the difference between the way the Federal Reserve was being 
looked at 6 months ago and the outcome as it relates to this 
regulatory bill. He should have spiked the ball before he sat 
down, but I guess Federal Reserve Chairmen do not show emotion 
in that way. But I know things have changed tremendously from 
that time, and I certainly appreciate you coming back and would 
want to talk to you a little bit about the report that you gave 
obviously was disappointing to the markets. I think people are 
a little concerned about where we are.
    Do you discuss much in your meetings the probability of a 
double dip? And can you give us some sense as to the future 
there?
    Mr. Bernanke. Well, we certainly try to talk about all 
contingencies, and the committee has identified some downside 
risks to the recovery, including problems of credit 
availability, small business, the high level of unemployment, 
which in turn has affected consumer confidence and their 
willingness to spend. So there are certainly some risks.
    But I would like to emphasize that our forecast, our 
expectation is still for a moderate recovery, the numbers I 
gave today of 3, 3\1/2\ percent, depending on the horizon, 
which will over time bring down the unemployment rate. So that 
is still our main scenario, that the economy will continue to 
grow and that the final demand, private final demand will take 
over from inventory building and fiscal policy as the drivers 
of growth.
    Senator Corker. The Ranking Member asked you a question, 
you know, obviously sort of the customary tools that you have 
or you have used in the past for easing, you know, with low 
rates, I think right after your testimony today the 10-year 
Treasury went to 292, rates are low, the Fed fund target is 
low, a lot of the sort of customary things are kind of gone. So 
he asked the question about what you may be thinking about, and 
you mentioned some nonconventional things. I know that then you 
alluded to some projections into the future that you all might 
use to maybe spur things along.
    I know in a 2002 speech you talked about the ability of the 
Fed to create inflation, and I am just wondering what you were 
saying, in essence, to the Ranking Member and what you might be 
referring to as it relates to projecting into the future.
    Mr. Bernanke. Well, my 2002 speech pointed out that there 
were other things the Federal Reserve could do besides lowering 
the overnight interest rate to try to stimulate the economy, 
and those things included making commitments or statements 
about the length of time that rates would be low. They included 
purchasing securities. They included intervening in financial 
markets that were dysfunctional, as we did during the worst 
parts of the crisis. And those are all things that we actually 
did in the last couple of years. And I continue to believe that 
there are additional steps that could be taken, but obviously 
we do need to think about them very carefully and also to 
evaluate the state of the economy before taking any further 
action.
    Senator Corker. What would be the hurdle or threshold that 
you would have to cross over before you would begin tightening?
    Mr. Bernanke. Well that has certainly got to be a committee 
decision, but I would say that certainly one important 
criterion would be whether the recovery is sustainable, whether 
it is fading and not being self-propelling. If the recovery is 
continuing at a moderate pace, then the incentive to take 
extraordinary actions would be somewhat less. But certainly we 
would want to make sure that the economy continues to move back 
toward a more normal state of resource utilization.
    Senator Corker. So I know a lot of people up here have 
tried to sort of take you in whatever direction they think they 
would like to take you as it relates to the deficit. I want to 
sort of ask it in a neutral way, and that is, look, we have got 
a debt commission right now that is looking at long-term 
issues. It is bipartisan. No doubt in my opinion the 
administration has added to our concerns in that regard. But if 
you really look at where our debt is, a lot of that has just 
been building for years because of many entitlements and other 
things.
    As a matter of fact, when you look at where we are over the 
next 10 years, regardless of what the factors are, I think the 
American people look at deficit reduction almost academically 
today, and yet in the near term, we are talking about draconian 
things having to occur. I know Erskine Bowles talked about 
getting to 21 percent of GDP. Some of us would like to see it 
at 18 to 20 as it relates to expenditures. But even getting to 
that level is going to take draconian steps.
    So my question gets back to monetary policy. I think you 
all know full well where we are headed, and I think the 
American people have not really digested what it means for us 
to get our house in order. I am not sure if any of us really 
have digested fully what that means.
    But how does that impact the decisions that you all make as 
it relates to monetary policy? I mean, you know that is coming. 
You know it is going to be draconian to deal with it in an 
appropriate way. How is it affecting your internal discussions 
as it relates to monetary policy?
    Mr. Bernanke. Well, it is a risk factor. Depending on how 
markets respond to developments in the debt and deficit, it 
could potentially be a drag on recovery if interest rates were 
to rise, for example. But in the near term, we are mostly 
focused on the business cycle, the state of the economy, the 
level of inflation.
    For the most part, I think of these fiscal issues as being 
medium term. For example, the objective of the Commission is to 
get the deficit down I think to about 3 percent, 3\1/2\ percent 
by the middle of the decade, something like that. And that is 
the kind of objective we want. We want to get the deficit down 
to a point where the ratio of debt to GDP sort of stabilizes, 
and that would, I think, be very good for confidence in the 
markets.
    Senator Corker. Evan Bayh mentioned at the hearing we had 
yesterday with Mr. Tarullo, he did a good job presenting. One 
of the things that we--in preparing for the meeting, we had 
somebody come in who is dealing with a lot of the foreign 
ministers and others, with the G-20, somebody that I think is 
respected by both sides of the aisle. And one of the things 
that he mentioned was the fact there was a lot of discussion by 
people in other countries regarding the legislation that we did 
just pass, and the fact that many of them saw the opportunity 
for jobs to migrate out of this country into theirs or for 
their particular institutions to fill in the gaps, to be able 
to take on additional business because of some of the things 
that we have done.
    I know that you and others are going to attempt to assure 
that we have sort of a worldwide set of regulations that work 
together. One of the things he specifically spoke to was the 
Volcker Rule, and there was a lot of resistance around the 
world community regarding that. And I am just wondering what 
your thoughts are on that and, you know, is there a concern in 
your mind today about us not achieving that and the fact that 
we may, in fact, lose financial system jobs here in the 
country?
    Chairman Dodd. Just answer that quickly, if you would.
    Mr. Bernanke. Well, the Volcker Rule was, I think, 
constructed in a reasonable way in that it allows continued 
hedging and market-making activities, which are critical 
activities for banks and other financial institutions. I think 
it is evident that the European banks will not adopt the same 
rule because they are universal banks and they have a different 
mode of operation. But our banks have been able to compete with 
European and other banks pretty effectively even though there 
have been differences in powers and other requirements. I do 
not see a major change in that competitiveness.
    Chairman Dodd. Very good. Senator Akaka.
    Senator Akaka. Thank you very much, Mr. Chairman. I want to 
add my welcome to Chairman Bernanke back to the Committee. We 
share a commitment to improving the lives of working families 
by better educating, protecting and empowering consumers.
    This is a great day for America and the American people. 
The Dodd-Frank Wall Street Reform and Consumer Protection Act 
became law today. One section of the act that will provide 
economic opportunities for working families is Title 12, which 
authorized programs intended to improve access to mainstream 
financial institutions and affordable small loans.
    Please share with the Committee the challenges that the 
unbanked and underbanked are confronted with, and explain why 
it is important that more people utilize banks and credit 
unions.
    Mr. Bernanke. Well, Senator, you have been a leader in this 
area for a very long time, and, of course, you are well aware 
that many people, particularly in many cases immigrants or 
minorities, are utilizing nonmainstream financial institutions, 
like payday lenders or check cashers, and that frequently that 
is very costly for them and may involve getting trapped in a 
cycle of debt where they have to continue taking out more loans 
at high interest rates in order to pay back their previous 
loans.
    So I think it is very important--and you and I have had 
this discussion on a number of occasions--to bring the broader 
public into the mainstream financial system, not only for 
deposits but for credit, for saving, for all the important 
functions of the financial system for families.
    I agree that there are some useful things in the bill that 
will address that, including financial literacy provisions as 
well. I believe the Consumer Protection Bureau will have some 
education and literacy components. That is very complementary. 
The Consumer Bureau will certainly be active in trying to 
eliminate deceptive, misleading advertising or products, but 
that alone is really not sufficient for people to make the best 
use of financial markets and financial products. They have to 
be educated as well. And, you know, I think that is very 
positive that we are going to increase the commitment to that 
training.
    Senator Akaka. Thank you. Chairman Bernanke, as you 
mentioned financial literacy, the recently enacted law includes 
a provision to establish the Office of Financial Education 
within the newly created Bureau of Consumer Financial 
Protection. The office will craft a strategy to develop and 
implement initiatives to improve financial literacy among 
consumers.
    What do you think must be done to ensure that consumers are 
able to make informed financial decisions?
    Mr. Bernanke. Well, as I indicated, I think this is a very 
important component of consumer protection, and I look forward 
to seeing the proposals and the ideas that come out of this 
office.
    I am very happy about the trend that we see across the 
country that more and more high schools are offering financial 
literacy courses. We have more organizations like Junior 
Achievement and others that are working with schools to 
increase financial literacy.
    I would have to say in all honesty that there are still 
some very difficult challenges in figuring out how best to 
educate people. Many of the programs that have been tried in 
the past have not been so successful based in terms of 
subsequent testing or evaluation of people who have taken those 
courses. So there are some difficult problems still in figuring 
out how best to transmit this information, how best to make 
sure people absorb it.
    One of the best ways to do that is to put financial 
literacy in the context of actual decisions that people make. 
If people are involved in buying a house or a car, they are 
much more involved and much more interested in the issues than 
they are if they are learning something in a high school class 
perhaps. So counseling and other kinds of support for people 
making financial decisions might be a good direction. But as I 
said, I applaud that the bill did not neglect financial 
literacy, and I hope that the Federal Reserve will be able to 
cooperate with the Bureau. As you know, we have our own 
programs, and we will continue to press education in this area.
    Senator Akaka. Chairman Bernanke, many hard-working 
immigrants send a portion of their earnings to relatives living 
abroad. The Dodd-Frank Wall Street Reform and Consumer 
Protection Act establishes long overdue requirements for 
simple, meaningful, and relevant disclosures about the cost of 
sending remittances. Additionally, the act requires that the 
Federal Reserve work with the Department of Treasury to expand 
the use of the automated clearinghouse system and other payment 
mechanisms for remittance transfers to foreign countries, and I 
look forward to continuing to work with you on this important 
issue.
    Mr. Chairman, what are the benefits of having consumers 
utilize banks and credit unions for remittances? And what must 
be done to encourage greater use of the mainstream financial 
institutions for sending remittances?
    Mr. Bernanke. Well, this is an issue I have spoken on in 
the past. We were just speaking about ways of getting 
particularly immigrant communities to get them into the 
mainstream financial system. Remittances, which is a very 
common practice for immigrants who are sending money home, is 
one natural way to get people into the mainstream financial 
system, and we have encouraged and we have seen many financial 
institutions improve their remittance services and use that as 
a way of attracting the interest of minority or immigrant 
groups. So I think it is a very useful way to make the 
transition from nonmainstream to mainstream finance.
    So we do support that, and you mentioned the ACH. The 
Federal Reserve has been involved a long time in developing 
better ways of transmitting remittances, and we have agreements 
with the Bank of Mexico to reduce the cost and increase the 
efficiency of remittances to that country. So we certainly are 
eager and prepared to expand those services, as is required by 
the new legislation.
    Senator Akaka. Thank you very much for your responses, 
Chairman Bernanke.
    Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator, very much.
    Senator Gregg.
    Senator Gregg. Thank you, Mr. Chairman. It is a pleasure to 
see you. I appreciate the good job you do for this Nation, and 
I am glad you are still independent.
    Obviously, you have brought us some information that is in 
some ways not all that optimistic: unusual uncertainty. 
Interesting term. Let me try to get to a couple of hopefully 
positive certainties. One would be if we were to do--if you 
look at the banking financial institutions today, the major 
ones, and you reflected in the terms of a stress test, which is 
what the Europeans are going through and what we have been 
through, do any of our banks have stress test issues of any 
significance right now?
    Mr. Bernanke. I am not quite sure what you mean by stress 
test issues, but we did do stress tests of 19 of the largest 
banks----
    Senator Gregg. I am talking about the largest banks.
    Mr. Bernanke. ----in the United States, and some of them 
were required to raise additional capital, all of which did. 
Since then, large banks have become increasingly profitable. 
Their losses on most categories of loans seem to have peaked, 
and in some cases they are reducing their reserves against loan 
losses. So the overall capital levels and the quality of the 
capital of large banks is certainly much improved over the last 
couple of years.
    Senator Gregg. The Chairman referred to an extraordinary 
quantity of excess reserves, which would imply that the banking 
system is fairly aggressively capitalized right now. Do you see 
that as being true? I mean the major banking system.
    Mr. Bernanke. Well, the excess reserves, which is about $1 
trillion held by the Federal Reserve, does not count--it is an 
asset. It does not count as capital. It is really a form of 
liquidity, and it helps to ensure that banks have all the 
access to liquid funds that they might need, and that it is 
another belt-and-suspender protection for the banking system.
    They have so far been reluctant to make use of those 
reserves, probably because they view the demand for credit as 
being weak or the quality of borrowers as being weak, or in 
some cases because they are uncertain about how much capital 
they will need in the longer term and are, therefore, being 
cautious about putting their capital to work. But capital 
reserves are different quantities.
    Senator Gregg. But they all reflect the strength of the 
system?
    Mr. Bernanke. Well, the excess reserves in particular, 
which are created by Federal Reserve purchases of securities in 
the open market, are a strength of the system in the sense that 
they ensure that banks have easy access to large amounts of 
liquidity. But it is a separate issue from capital.
    Senator Gregg. Well, I guess my point is: Isn't our 
financial structure in pretty good shape right now compared to 
where it was a year and a half ago? And isn't it moving in the 
right direction? And so when you say ``unusual uncertainties,'' 
isn't at least one certainty that at least that element of the 
crisis which we confronted a year and a half ago has been 
settled out and is moving in the right direction?
    Mr. Bernanke. Yes, I took note of that in my remarks, that 
both the banking system and the financial markets more 
generally are in considerably better shape than they were 2 
years ago.
    Senator Gregg. Senator Reed referred to $2 trillion on 
asset balance sheets across this country in corporate America. 
Now, I have heard this refrain a series of times from the other 
side of the aisle now. It is almost as if that $2 trillion 
should be ours, it should be the Federal Government's and we 
should get it reallocated right now because it is sitting 
there. But isn't it really a reflection of the fact that we are 
poised for some positive activity if confidence can return to 
the markets? In other words, there are resources for capital 
expansion and for economic expansion sitting on the books.
    Mr. Bernanke. That is right. The availability of funding or 
credit is not a constraint for most large firms.
    Senator Gregg. What is the constraint, of course, is the 
unusual uncertainties that are facing American business today, 
and small business especially, but all business, and that is 
that we are facing a Government that has got a long-term debt 
which is unsustainable, and so there is a huge uncertainty as a 
result of that. In the short term, it is a two-step dance. We 
understand that in the short term there is a stimulus event 
here that is occurring. But in the long term, we have an 
unsustainable debt. Is that not true?
    Mr. Bernanke. Yes.
    Senator Gregg. And that within the next year, it is the 
administration's position that major tax events will occur 
which will significantly dampen the creation of capital. 
Specifically, capital gains rates will go up by 50 percent; 
dividend tax rates will go up by 150 percent on some earners; 
and top marginal rates will go up from 35 percent to 42 
percent, which dampens capital formation. Doesn't a major tax 
event like that in a slow economy dampen capital formation?
    Mr. Bernanke. Well, again I do not want to be recommending 
for or against specific taxes, but obviously, as you look at 
the Tax Code, thinking about this not only in the short term 
but in terms of demand stimulus and long term in terms of 
efficiency and effectiveness, I hope you look at it from both 
perspectives.
    Senator Gregg. Well, if you tax the formation of capital 
over the next 6 to 8 months at a rate which is 50 percent 
higher than it is today or 150 percent higher than it is today, 
you are probably going to slow economic activity. That is 
rhetorical.
    And then, of course, you have the issue of the financial 
reform bill. I mean, there is going to be a period here where 
people are not going to--a lot of the banking industry is not 
going to know what sort of capital reserves it should actually 
be holding, which will constrain its willingness to go out and 
lend; where the derivatives market is going to be frothy, to be 
kind, because it will not really know where it is ending up and 
what type of derivatives have to have margins; and where under 
the Volcker Rule a large amount of proprietary trading which 
used to be available will no longer be available to American 
banks, although ironically it will be available to 
international banks. All of that will contract credit to some 
degree in the market, will it not, over the next 6 months to 2 
years as people sort out their responsibilities here?
    Mr. Bernanke. Those are legitimate concerns, and for that 
reason the Federal Reserve is going to do the best we can to 
get these things resolved as quickly as possible.
    Senator Gregg. So if you want to look at what is really 
causing--maybe the uncertainty that is causing this $2 trillion 
to stay on the balance sheets, it is the fiscal policies of the 
Government.
    Mr. Bernanke. Policy uncertainties are no doubt part of it, 
but there is also economic uncertainties, just uncertainty 
about how labor markets will evolve, how consumer spending will 
evolve, how the global economy will evolve and so on. So there 
is a lot of uncertainty, and that is certainly an issue.
    Senator Gregg. If you were doing a formula, I think the 
percentage that would be assigned to Federal fiscal policy 
would be fairly high for creating uncertainty as a result of 
our unwillingness to face the long-term debt problems we have, 
the tax policies which are coming at us which will penalize 
capital formation, and the uncertainty about what sort of 
capital you have to have on your books in order to make loans 
in the financial institutions for at least the next 6 months to 
2 years.
    Chairman Dodd. Let me just point out before I turn to 
Sherrod Brown, because we are losing some members, but I say 
this to the staff in the room, as well, in consultation with 
Senator Shelby, I would like to be able to move our nominees 
for the Federal Reserve out of committee before the August 
break, and I know they were with us a few days ago. So if my 
colleagues have questions for them in addition to what they 
asked during the confirmation hearing, if you haven't submitted 
questions, I would urge you to do so.
    I haven't scheduled anything yet. I am obviously going to 
stay in touch with all of you. Just let me know whether or not 
you have had questions answered or not so that we could try and 
get those done before--at least out of the committee. I am not 
trying to get it up before the full Senate, obviously, before 
we leave, but at least set it up. So I would urge you to submit 
questions if you have them, to members, and I thank you for 
that.
    Senator Brown.
    Senator Brown. Thank you, Mr. Chairman.
    Chairman Bernanke, welcome. Last time you were here, 
several months ago, you and I talked about manufacturing, its 
role in our economy, that manufacturing, typically automotive 
but manufacturing generally is the vehicle, if you will--pardon 
my pun there--to lead us out of recession. I mentioned to you 
that 30 years ago, more than a quarter of our GDP was 
manufacturing and financial services made up only about a tenth 
of our GDP, and in the last 30 years, we have seen that flip 
and we know where that got us. It got us a shrinking middle 
class. It got us our financial crisis, in part, not quite that 
simple, but we know that if we don't make things in this 
country, that it is a significant problem of getting out of a 
recession and beyond that.
    Also in the last several months, the International Trade 
Commission, signed of on more or less by the President and the 
Commerce Department, made two rulings, one of them on Chinese 
tires, one of them on--that was last fall. Since you have been 
in front of this committee, they made a country on oil country 
tubular steel. Each of those rulings found that the Chinese 
weren't playing fair on subsidies, dumping. Each of those 
rulings resulted immediately in American companies in my part 
of the country and beyond, in tires, especially, hiring several 
hundred people.
    Back in December 2006, and this gets me to comments that 
Senator Bayh touched on, in December 2006 at the U.S.-China 
Strategic Economic Dialogue, you described China's undervalued 
currency, quote, ``as an effective subsidy for Chinese 
exporters.'' You know how many jobs depend on our trade 
deficit, or we hope shrinking deficit--not a lot of evidence 
for that long term that I can see, although you touched on 
that.
    But explain whether you believe, in your words, effective 
subsidy is still in place and whether the G-20's commitment to 
rebalance growth can be achieved with this apparently slow and 
gradual appreciation of the yuan.
    Mr. Bernanke. Well, this is related to my answer to Senator 
Bayh about the current account deficit. There are two tools to 
address imbalances. One is exchange rate flexibility. The other 
is to rebalance your economy so that it is more dependent on 
domestic demand rather than on exports.
    On the latter, the Chinese have made some progress. Through 
fiscal policy and other policy actions, they have increased 
somewhat their dependence on their own domestic demand rather 
than excessive reliance on exports, to some extent. I mean, 
there has been progress in that direction.
    On the exchange rate they have recently begun again to 
undertake this controlled float that they have. Obviously, it 
hasn't moved the exchange rate very far, and I would agree with 
you that we would like to see them move it considerably further 
so that it would both create a level playing field, as your 
concern addresses, but also from the perspective of China, to 
give them a more balanced domestic economy and more 
independence of their monetary policy. So it is really 
something that is important for both sides.
    Senator Brown. One thing China seems to understand better 
than we when they make these very, very small baby steps on 
currency appreciation is time. Thirty year ago, Zhou Enlai was 
asked what he thought of the French Revolution and he said it 
was too early to tell. It just seems to me that China plays us 
out on this currency and continues its--it is, as you say, an 
effective subsidy. I assume you haven't changed your mind that 
it is an effective subsidy. You would use that term again?
    Mr. Bernanke. Yes.
    Senator Brown. OK. Would you agree with many, many 
economists who have been parts of both Democratic and 
Republican administrations that the subsidy approaches 40 
percent?
    Mr. Bernanke. I don't know exactly. There is a range of 
estimates that are----
    Senator Brown. Would you give me your range of estimate?
    Mr. Bernanke. The numbers that you see in the literature 
range between 10 and 30 percent.
    Senator Brown. No, they range--many say 40.
    Mr. Bernanke. I don't think that is the center of the 
distribution but there is a wide range.
    Senator Brown. Well, 10 to 30, I am not asking the center--
--
    Mr. Bernanke. Right. Sorry.
    Senator Brown. ----ten to 40, the center is still not 40. 
You are pretty good at math, so what is the range and where do 
you come down? I want you to be more specific than 10 to 
something.
    Mr. Bernanke. Could I come back to you with some numbers?
    Senator Brown. Could you discuss it a little more now? So 
the range is--I am sorry I interrupted you. The range is 
something. Give me the range that you see----
    Mr. Bernanke. So the range----
    Senator Brown. ----and where you might----
    Mr. Bernanke. ----that I have seen through a variety of 
ways of calculating it is generally, in my recollection, 
somewhere between 10 and 30 percent.
    Senator Brown. OK. Does that mean that Chinese goods sold 
into this country are underpriced 10 to 30 percent?
    Mr. Bernanke. Yes, holding constant some other things like 
wages, which have started to rise, for example. But broadly 
speaking, yes.
    Senator Brown. And doesn't that mean that it should be no 
surprise we have this sort of this huge bilateral trade deficit 
with China?
    Mr. Bernanke. Well, it is a function both of the exchange 
rate, and I am not disagreeing with you, but it is also a 
function of savings and investment policies. And again, China 
has made some progress toward increasing the dependence of its 
economy on its own domestic demand.
    Senator Brown. If we were to enforce two issues where there 
have been petitions through the Commerce Department, one on 
coated paper, another on aluminum, two actually fairly major 
industries in the country, if we were to make the decision and 
enforce the laws that there is, in fact, as we do this study, 
that there is, in fact--or this investigation--a currency 
subsidy, if you will, is it fair to assert that absolutely 
would mean job growth, that it would mean job growth in this 
country, our country?
    Mr. Bernanke. There would certainly be a short-run effect 
on those particular industries, but I would point out that 
there is not much correlation over a longer period of time 
between overall employment or unemployment and our current 
account deficit, that where resources are not being utilized in 
one industry, they tend over time to be deployed in other 
industries. So maybe there is some misallocation across 
industry, but overall employment doesn't depend too much on the 
current account.
    Senator Brown. That is a story that would ring hollow to 
lots of cities in my State, large and small alike, like your 
city in South Carolina, understanding how capital moves and 
families can't often.
    But if, in fact, and I will wrap up with this, Mr. 
Chairman. I see my time has expired. Current account deficit 
notwithstanding, if the currency is so, your term, if the 
undervalued currency is an effective subsidy, doesn't that 
always mean lost jobs in a bilateral relationship when trade is 
going back and forth--more back than forth--on these 
commodities or these manufactured goods?
    Mr. Bernanke. It could mean that there is a transfer of 
jobs across different industries. It doesn't necessarily mean 
overall, that jobs are lost.
    Senator Brown. But when the overall net effect--you can 
talk about it is not like we are losing jobs in paper, we are 
losing jobs in chemicals, we are losing jobs in steel, we are 
losing jobs in aluminum, we are losing jobs in glass and we are 
picking it up in other manufacturing. I mean, the net loss is 
manufacturing writ large, correct?
    Mr. Bernanke. Well, what is happening is that the jobs are 
being picked up in nontraded areas, in goods and services that 
we don't trade abroad.
    Senator Brown. Perhaps. Thank you.
    Chairman Dodd. Thank you, Senator.
    Senator Tester.
    Senator Tester. Thank you, Chairman Dodd.
    Welcome, Ben. I appreciate you being here. I want to step 
back to some questions that were asked earlier, and you said--I 
think it was in response to Chairman Dodd, but it may have been 
in your opening statement, where you talked about the 
expenditures being made now were necessary to keep the economy 
propped up and keep it going, and correct me if I am wrong. And 
then another question was asked shortly thereafter. You had 
said that the deficits are unsustainable right now. Those seem 
to be competing statements, although they can go together. The 
question is, from your perspective, the expenditures we are 
doing right now, regardless of the deficit, are necessary?
    Mr. Bernanke. Broadly speaking, yes. I don't think that 
there is really much benefit to trying to reduce the 2010 
deficit substantially. I think that that is supporting the 
economy. Those two statements are not inconsistent. It has to 
do with the timeframe.
    Senator Tester. OK. I just want to make sure that that is 
the case, because I think sometimes we interpret them as being 
diametrically opposed when they are not.
    Mr. Bernanke. I would much prefer to see consolidation or 
cuts over the medium term as opposed to immediately.
    Senator Tester. Let me get to that, because we all know 
that large and unsustainable deficits, as you have pointed out 
in the past, ultimately, we are going to have to make some 
tough decisions. Ultimately, we are going to have to make some 
choices, none of which will be easy, whether you are talking 
about cutting expenditures or increasing the income.
    What are the indicators that you would use to determine 
when we start addressing those issues, and is today the day we 
start or when do we start?
    Mr. Bernanke. Well, I think if you look at, for example, 
the CBO and other projections, they have deficit-to-GDP ratios 
from, say, 2013 to 2020, somewhere in the four to 7 percent 
range. Assuming that the economy is back to close to full 
employment by 2013 or 2014, that four to 7 percent is the 
medium-term structural deficit and that is too high to keep the 
debt-to-GDP ratio constant over time. It is going to lead to an 
unsustainable situation.
    So in particular, the Deficit Commission has been tasked to 
bring the deficit down to 3 or 3\1/2\ percent, something in 
that range, by 2015. I think we ought to be shooting for a 
sustainable path, 3 percent, maybe even less, of GDP as a 
deficit starting 2 or 3 years from now and going out for the 
next decade, would be one broad trajectory that would be 
reassuring to the financial markets.
    Senator Tester. Is 3 to 3\1/2\ percent of GDP sustainable?
    Mr. Bernanke. It depends on lots of different things, but 
you don't have to have a zero deficit for sustainability. You 
just need the deficit to be roughly equal to the interest 
payments that you make. So if interest payments are 2 to 3 
percent of GDP, then a permanent deficit of that amount is, in 
fact, sustainable. Yes.
    Senator Tester. OK. The G-20 met recently and they set up a 
timeframe for deficit reduction. Do you think that that 
timeframe is appropriate?
    Mr. Bernanke. It is 2015, I believe?
    Senator Tester. I think half the deficit by 2013.
    Mr. Bernanke. A majority of them are emerging market 
economies, many of which are actually growing pretty quickly 
right now, so I am not sure I would want to impose a single 
standard on all the members of the G-20. The important thing is 
the overall trajectory. Is there some evidence that the debt 
will begin to stabilize within the next few years?
    Senator Tester. OK. Investors have been--I mean, the 
Treasury bonds have been pretty solid, and that is maybe an 
understatement. How long do you think this will remain this 
way, and is it dependent on what is going on in Europe right 
now that they are solid, or is there another reason for it?
    Mr. Bernanke. Well, there are a number of reasons why the 
yield is under 3 percent----
    Senator Tester. Right.
    Mr. Bernanke. ----currently. They include low inflation 
expectations, low growth expectations, but very importantly, 
also safe haven effects. That is, the U.S. dollar or U.S. debt 
is considered to be very liquid, very safe instrument, and 
given the amount of risks in the financial markets around the 
world, many investors have decided to acquire U.S. dollars, 
including many foreign governments who want to hold dollar 
reserves. So those are some of the reasons.
    Clearly, the bond market at this point is not focused on 
long-term deficits, at which point it would become more 
concerned. It is very hard to know.
    Senator Tester. Some have said that there is going to be--
there is strong potential for another dip due to commercial 
real estate and other things. What impact does that have on the 
Treasury bonds?
    Mr. Bernanke. Well, just to be clear----
    Senator Tester. If it would happen.
    Mr. Bernanke. Just to be clear, the Federal Reserve's 
forecast is for moderate recovery. But if, for whatever reason, 
there were a significant slowdown, then presumably Treasury 
yields would fall further.
    Senator Tester. OK. So, I mean, so Treasury doesn't--and I 
am happy to hear you say yes to this question--Treasury doesn't 
see another dip due to commercial markets?
    Mr. Bernanke. The Federal Reserve?
    Senator Tester. The Federal Reserve, I mean. I am sorry.
    Mr. Bernanke. No, we don't think that a double----
    Senator Tester. That is good.
    Mr. Bernanke. ----is a high probability event.
    Senator Tester. That is good news. You had talked about--in 
fact, it was Ranking Member Shelby who had some questions on 
the credit crunch and the reason for it. You had talked about 
lower demand. You had talked about collateral, the value 
decline. You talked about regulators being especially cautious. 
I want to touch onto that. You said that you were instructing 
regulators to be more--have more consistency in their 
regulation. Consistency goes to stability goes to better 
lending. How are you evaluating that?
    Mr. Bernanke. Well, first, in terms of what we are doing, 
we have put out a lot of specific guidance in terms of how you 
go about making these evaluations with lots of practical real 
world examples, and we have put out guidances about commercial 
real estate, about small business, and a number of other key 
areas. And we have been following that up with very intensive 
training of the examiners to make sure they understand that 
there needs to be an appropriate balance between appropriate 
prudence and making loans to creditworthy borrowers.
    In terms of evaluation, we are doing this a number of ways. 
We are gathering more data. For example, we are now gathering 
on a quarterly basis lending to small businesses instead of 
annually. We are contributing questions to the NFIB's Survey of 
Small Businesses to try to understand what problems they see. 
Very importantly, as I mentioned in my testimony, we have had a 
series of 40 meetings around the country, meeting with banks, 
small businesses, and other relevant parties to talk about the 
issues, and we have put together an addendum to my testimony 
which includes a number of findings and recommendations to 
address this.
    So we have been both qualitatively and quantitatively 
trying to assess the effects of our guidances and training on 
bank activity.
    Senator Tester. OK. Just one last thing, Mr. Chairman, if I 
might, and then I will throw it over, because it is on this 
issue. I continually, when I go into the State of Montana every 
weekend or when I come back here, I am continually getting 
calls from banks, community banks, that are saying the 
regulation isn't consistent. It is not consistent between 
agencies. It is not applied across the board within agencies in 
a consistent way. I said, you know what? I would love to call 
these guys up. And they said, don't use our name. If you use 
our name, it will be worse.
    There has got to be a way that you, being the person you 
are, can go out and dig down and get that information, because 
quite honestly, I believe the banks because I hear it from 
every one of them. So if you could do that, I would certainly 
appreciate it.
    Mr. Bernanke. I invite those comments. If they are 
unwilling to talk to their Federal Reserve Bank in their 
district, we have an Ombudsman here in Washington who will be 
happy to take those comments, and our Bank Supervision 
Department will be happy to take those comments. So we want to 
hear that.
    Senator Tester. Once again, thank you for being here, 
Chairman Bernanke. Thank you.
    Chairman Dodd. Senator Bennet.
    Senator Bennet. Thank you, Mr. Chairman. Thank you for 
holding this hearing, and to the Ranking Member, thank you, and 
thank you for being back here, Mr. Chairman.
    I actually want to pick up right where Senator Tester left 
off, because the last time we were together, I asked whether or 
not we might have some metrics where we could start to look at 
things and be able to distinguish between lending that is not 
happening because of loan demand, lending that is not happening 
because of regulators' overreach, lending that is not happening 
because we are in a different leverage environment, all that 
stuff, and I was pleased to see that in the addendum you have 
talked about it a few times.
    There is a section on research and data, what you are going 
to start collecting, what you have heard from people that might 
make it more meaningful, and for the life of me, there are a 
million things in here that I don't know why we haven't done 
already, but we haven't. We haven't had the focus on small 
business lending that we need to have. I don't think the 
administration has had the focus on it that they need to have.
    But my question is--and my anecdotal evidence in Colorado 
continues to be exactly the same as Senator Tester's, which is 
that small businesses that assert that they can pay on their 
loans can't get credit, and banks are saying that the reason 
they can't extend the credit is because the regulators have 
swung too far over to one side. It is a consistent theme. Every 
now and then, you hear somebody say, well, there is not really 
loan demand, or they will say, Michael, look and see if people 
are actually paying off their letters of credit and they are 
returning capital to banks.
    So my question for you is, you talked about the training 
and the guidance, wanting people to take a balanced approach. 
In the evidence that you have collected so far that you were 
just talking about, what is the evidence? What does it tell you 
about what is happening here?
    Mr. Bernanke. Well----
    Senator Bennet. Or do we not even now----
    Mr. Bernanke. I don't know if I could give you a completely 
final answer on this. I think we are pretty confident that a 
lot of the reduction in lending is not regulatory constraint, 
that a lot of it has to do either with reduced demand from 
small businesses or from the fact that their financial and 
economic position has been weakened so that it is more 
difficult for them to get a loan with the tighter standards 
which now exist in the banking system. So that is a big part of 
it.
    I don't have definitive answers for you that you would want 
on the regulatory, but let me give you an example of something 
which we are currently doing that I didn't mention to Senator 
Tester, which is we have done baseline analyses, evaluations. 
We have gone out to 200 or more banks and asked them how they 
dealt with commercial real estate problems, workouts, 
relending, refinancing, and so on, and we are doing a follow-up 
subsequent to our guidance on this issue. And what we want to 
try to do is identify whether there have been changes in 
behavior. So we are trying to get the metrics that you are----
    Senator Bennet. Is your sense that the--and what I hear a 
lot is we used to reserve 10 percent. The requirement is now 12 
percent, or it was 9 percent, it is now 12 percent. Do you 
think that the regulators are striking the right balance there?
    Mr. Bernanke. I am sorry, I didn't understand the question.
    Senator Bennet. They are saying that the assets that they 
have to reserve that they can't lend have increased from, I 
think it is 9 percent to 12 percent.
    Mr. Bernanke. There is no simple rule like that. There is 
an evaluation of the overall quality of the loan, which depends 
on a variety of things, so there is not----
    Senator Bennet. OK. They feel like--in my State, they feel 
like there is a simple rule like that.
    Mr. Bernanke. So there are data. Some of the data that we 
look at are a survey we do of 100 banks of loan officers and 
ask them whether they are tightening or easing standards, and 
they have been tightening for quite a while. So some of this 
surely is the banks' decision to tighten their lending 
standards. Now, recently, we have seen a cessation of 
tightening. That is, standards are no longer getting tighter. 
In some places, they are getting a little bit easier. So there 
is some stabilization there. We have also seen that small 
business lending is still dropping, but more slowly than 
before.
    So there are some indications that credit is becoming more 
available. Whether that has to do with regulatory decisions or 
whether it has to do with the fact that the economy is looking 
a little better is hard to say.
    Senator Bennet. I wanted to, just before I lose my chance 
here, also talk a little bit about the deficit and the debt 
situation. You talked about how the markets need to see a 
compelling--that we are taking it seriously. You have testified 
to that before. Actually, they are not the only ones. My 
daughters have heard me talk about this so much that they are 
enormously agitated about this question themselves, because 
they don't want to make these decisions that we are failing to 
make.
    But Congress after Congress after Congress have failed to 
make the decisions, and we now have $13 trillion debt on the 
balance sheet. What is appalling about it, among other things, 
is that we really don't have much to show for it, I don't 
think. We haven't invested in this country's infrastructure, 
for example. We haven't built the 21st century energy 
infrastructure that we need. So the hole is actually even 
greater than I think we imagine from a fiscal point of view.
    You mentioned at the very beginning the difficulty of 
having one Congress bind the next Congress and the next 
Congress. What kind of thing do you think about when you are 
not here but in your office that we could do that would show 
that we are serious about this, that we are actually putting 
ourselves on a path of sustainability, knowing that we can't 
fix this overnight? What is it that we--what will do we need to 
demonstrate and how do we need to demonstrate it? I realize--I 
am not asking for specific policies, but what do you say to 
yourself?
    Mr. Bernanke. Well, Congress has over time moved toward 
multiyear budgeting plans, and you try to look at projected 
trajectories over a 10-year window. So those kinds of 
exercises, where you are looking at how programs will affect 
the deficit over a 10-year period is certainly one way to 
demonstrate commitment, and a future Congress could reverse 
what you did, but they at least would have to take active 
action to do that, and you could demonstrate your commitment to 
gradual deficit reduction over a period of time.
    At some point, you are going to have to address in some way 
or other the unfunded liabilities associated with entitlements. 
The problem there is that it doesn't seem likely that you would 
want to change those for people who are near retirement.
    Senator Bennet. Right.
    Mr. Bernanke. Even any changes you would make today are 
going to only take effect relatively far in the future. And so 
part of the challenge is to find things that will affect the 
trajectory, say, between now and 2020, which is what the 
Commission is looking at.
    Senator Bennet. Mr. Chairman, may I ask one more question, 
or are we done----
    Chairman Dodd. Yes, very quickly, if you can.
    Senator Bennet. Do you think--one of the things that I 
worry about is that as we recover, we forget that we have got 
these obligations that we have got to deal with, and people 
will cut taxes and not pay for it or spend money and not pay 
for it. Do you think that it would be possible to create a 
legislative instrument to help manage our deficit to a 
percentage of GDP, that we would be saying to ourselves that we 
have a policy objective that says, by such and such a year, the 
budget deficit can't be greater than 3 percent of GDP or lower?
    Mr. Bernanke. It is certainly possible. There have been a 
variety of different kinds of rules over the years that 
Congress has tried to impose on itself, sometimes successful, 
sometimes less. You have a created Congressional Budget Office, 
which is a neutral arbiter and which has been very useful in 
trying to make sure people are making an honest assessment of 
the costs of their programs or tax cuts.
    So, yes, I think there probably are a range of ways of 
constraining future deficits, and if you look around the world, 
many countries either have constitutional provisions or they 
have a nonpartisan office that enforces certain constraints. Of 
course, the States have balanced budget requirements which are 
not perfectly enforced, but do constrain their spending, 
obviously.
    Senator Bennet. Thank you. Thank you, Mr. Chairman.
    Chairman Dodd. Thank you, Senator.
    Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    Thank you, Chairman Bernanke, for your service. I always 
believe the starting point always has consequence, and I hear a 
lot about spending, which I agree is a challenge and something 
we need to tackle, but I also hear it in the abstract. So let 
me just do a very quick history line with you.
    You came to us in the end of 2008 with Secretary Paulson 
and you said to this Congress, we need to act or otherwise we 
will have financial institutions collapse and that collapse 
will mean an entire systemic risk to the entire country and 
maybe we will even have a global financial meltdown. Is that 
true?
    Mr. Bernanke. Absolutely.
    Senator Menendez. So that was necessary.
    Mr. Bernanke. Yes.
    Senator Menendez. And then we asked you in the beginning of 
2009, when President Obama--that happened before President 
Obama took office. And then President Obama takes office in 
2009 and we have an economy that has flat-lined, is that fair 
to say?
    Mr. Bernanke. You have a----
    Senator Menendez. An economy that was flat-lined, with 
absolutely no----
    Mr. Bernanke. Yes.
    Senator Menendez. We had negative growth.
    Mr. Bernanke. Very weak, yes.
    Senator Menendez. We were losing three-quarters of a 
million jobs in January and February and March of 2009.
    Mr. Bernanke. That is correct.
    Senator Menendez. We had negative GDP growth, is that 
correct?
    Mr. Bernanke. Yes.
    Senator Menendez. And then we needed to stimulate that 
economy because it just had no private sector activity, for all 
intents and purposes, is that correct?
    Mr. Bernanke. Yes.
    Senator Menendez. And, therefore, that was necessary.
    Mr. Bernanke. Well, I never specifically endorsed any 
particular program, size, composition, and so on----
    Senator Menendez. But you then assisted to stimulate the 
economy.
    Mr. Bernanke. ----but stimulus was certainly beneficial, or 
certainly was useful in the context of the weak economy we had 
at the beginning of last year.
    Senator Menendez. Well, if we had done nothing, would it 
have been worse?
    Mr. Bernanke. Probably, yes.
    Senator Menendez. OK. So it was necessary. So I have a 
little difficulty in understanding some of our colleagues from 
their starting point. Let me ask you now, now, if we do 
absolutely nothing, what is the economy going to look like?
    Mr. Bernanke. Well----
    Senator Menendez. What is the job picture going to look 
like?
    Mr. Bernanke. Our baseline analysis is that there will not 
be another large fiscal stimulus, and based on that, we have 
come up with the forecast which I reported today which is for 
moderate recovery.
    Senator Menendez. But you are also looking at monetary 
policy as a way, possibly, to see if you can further 
stimulate--my word--the economy, not?
    Mr. Bernanke. That is correct.
    Senator Menendez. Well, that is an action that will have 
somewhat of a cost. So it is--we have choices here. We could 
have done nothing, spent nothing and had a global financial 
meltdown, or we could have acted and prevented that because the 
consequences would have been far greater. A global financial 
meltdown means a depression in the 21st century. That would 
have been far different than the depression that you studied 
under Roosevelt, would that not be true?
    Mr. Bernanke. Senator, I have never objected to the 
spending that was done to address----
    Senator Menendez. I know you haven't. I am just trying to 
get the record here straight.
    Mr. Bernanke. Right. I think that the fact that we have a 
10-percent GDP deficit this year is completely understandable 
given what we have been through.
    Senator Menendez. So we are looking at debt and deficits 
now, and I agree we need to tackle that. So adding another $680 
billion to the debt, is that a good idea?
    Mr. Bernanke. It depends on----
    Senator Menendez. Well----
    Mr. Bernanke. Everything else being equal, raising the debt 
is a negative.
    Senator Menendez. So raising the debt is a negative. And if 
I do that in a way in which I don't offset that, that would be 
a negative, would it not be?
    Mr. Bernanke. From the debt perspective, yes.
    Senator Menendez. From the debt perspective.
    Mr. Bernanke. Yes.
    Senator Menendez. Now, but that is, in essence, what some 
of our colleagues want us to do in extending the tax cuts that 
are expiring and not pay for them. And so I just don't 
understand how we reconcile those views.
    Is it permissible never to pay for tax cuts than what they 
drain the Treasury of? Is that a good fiscal policy?
    Mr. Bernanke. If you don't control the deficits over time, 
eventually, the markets won't lend to you at reasonable 
interest rates.
    Senator Menendez. Now, speaking about lending at reasonable 
interest rates, if we continue--you know, my colleagues from 
Montana and Colorado, I could echo in New Jersey the reality of 
what banks tell us, particularly community banks and others. So 
it gets to be a little wide swath of the same set of statements 
that are being made, which always make me think a little bit 
about the truthfulness in terms of there seems to be more 
voracity when I continuously get from a wide range of entities 
the same answer.
    But if you can borrow from the Federal Reserve at, what is 
it, one point?
    Mr. Bernanke. The discount window is 75 basis points, but 
we are not making many loans through that.
    Senator Menendez. But if you can borrow incredibly low and 
then go buy Treasury bills, why would you take risk to make 
loans?
    Mr. Bernanke. It is still profitable. If you can make a 
good loan, it is still profitable. Buying Treasury bills with 
short-term money is not an arbitrage. It is a risky way of 
making short-term profits at the risk of long-term capital 
losses.
    Senator Menendez. Let me ask you this. Why is it that we 
hear from bank after bank after bank after bank that in the 
regulatory aspect, we are telling, for example, in commercial 
loans that are performing--performing--that, however, they need 
to be recapitalized. Well, if we do that, we are going to dry 
up an enormous amount of capital, especially as we are looking 
at a commercial mortgage market problem that I think is going 
to be incredibly troublesome.
    Mr. Bernanke. Senator, if I may make a couple of comments. 
One is that there are a number of different bank regulators, as 
you know, and there may be differences among the regulators in 
terms of how aggressive they have been at trying to maintain 
this appropriate balance. I don't know.
    Speaking for the Federal Reserve, which oversees about 10 
percent of community banks, we have made a very strenuous 
effort to try to achieve that appropriate balance. It is also 
possible, I mean, that the banks may be blaming examiners when, 
in fact, it is their own reluctance to lend which is really the 
problem. But I agree with the basic point that we need to do 
everything we can to make sure that banks make good loans, that 
if a creditworthy borrower comes, that they can get credit.
    With respect to your particular point, one of the specific 
elements of our guidance is that a decline in the value of the 
property, the commercial real estate is in itself not a reason 
not to make a loan if the cash-flow is adequate to make 
repayment. So we have been clear about that particular issue.
    Senator Menendez. Finally, I hear from the business 
community that they need certainty. Well, it seems to me they 
have certainty in the health field as a result of the law. They 
now have certainty in financial services regulations, or, I 
should say, the financial services, the Wall Street reform 
legislation. And I just want to make sure that my colleagues 
look at your testimony where you say that legislation 
represents significant progress toward reducing the likelihood 
of future financial crises and strengthening the capacity of 
financial regulators to respond to risks that may emerge, and 
you go on to say, I believe that the legislation, together with 
stronger regulatory standards for bank capital and liquidity 
now being developed will place our financial system on a 
sounder foundation and minimize the risk of a repetition of the 
devastating events of the past 3 years--the past 3 years. I 
think it is incredibly important to highlight that part of your 
testimony. Thank you for it.
    I thank you, Mr. Chairman.
    Chairman Dodd. Thank you very much, Senator Menendez.
    Let me, if I can, Judd Gregg, who I have a lot of respect 
for, raised the issue that uncertainty in fiscal policy was 
the, as he sees it, is one of the reasons for the lack of 
activity here. I am wondering if it is also--I mean, it seems 
to me that you are getting businesses with this low-growth 
capacity, where they are just--the demand isn't there. It seems 
to me that is as much of a factor here as anything else. I 
wonder if you might comment on that. Again, I am not trying to 
engage you into taking a side on this debate one way or the 
other. I think there is clearly some uncertainty out there, as 
you have described it. But it seems to me, as well, if people 
aren't--there isn't the capacity, the growth capacity, there is 
no demand. Therefore, people are not--the economy is not 
growing. How much of this can describe that?
    Mr. Bernanke. Demand is certainly very important, 
absolutely. Firms have a lot of excess capacity. They are not 
making use of the factories and the buildings and the equipment 
they have now, and so that reduces their incentive to invest 
further.
    Chairman Dodd. Well, we have a lot of buildings that are 
just sitting idle, vacant.
    Mr. Bernanke. That is right.
    Chairman Dodd. So the utilization is--capacity utilization, 
there is no demand for it, it seems to me. That has an awful 
lot to--I just think that has to be added as a major factor in 
all of this. I gather you agree with that.
    Mr. Bernanke. Certainly the lack of demand, even the small 
businesses we were talking about, when they talk about what is 
their number one problem, it actually is not credit. It is lack 
of demand.
    Chairman Dodd. Let me jump, if I can--I did not get into 
this stuff. Several members raised questions with you about, in 
the financial reform bill, the role of the Federal Reserve. I 
wanted to raise the issue of the responsibility to impose that 
heightened capital liquidity and leverage standards on bank 
holding companies and designated nonbank financial companies, 
and obviously the harmonization issue, which we have talked 
about, is going to be critically important.
    But, in your view, will such standards need to be set 
significantly higher than they are at present in order to 
reduce the likelihood of another fiscal or financial crisis?
    Mr. Bernanke. We are trying simultaneously to think about 
the small versus large bank or systemically critical versus 
noncritical bank capital issues. At the same time, we are 
looking with our colleagues internationally to try and 
establish relationships between capital standards across 
countries. So I do not think we really have come to a 
conclusion there. It is not a straightforward thing to answer 
that question, in part because large banks and small banks have 
such different portfolios and such different activities that 
they will have different capital levels even for the same set 
of rules. We are committed by the legislation and by our own 
approach, to requiring more capital of systemically critical 
firms, and in a progressive way as firms become even more 
critical, interconnected, essential to the functioning of the 
system that they need to both have higher capital and to be 
subject to tougher prudential regulation because of the effects 
they have on the whole system if they fail.
    Chairman Dodd. Well, let me ask you this, because there has 
been--we will get a lot of Monday morning quarterbacking on the 
bill, I presume for years to come. There was a proposal in one 
of the versions of the bill to actually set standards in the 
legislation. I opposed that idea because of the very answer you 
just gave to my question. And I am drawing the conclusion there 
that you think we did the right thing by not trying to set a 
specific standard in the legislation but allow for more nuanced 
response to it, again, based on the size of the institution we 
are talking about, the kind of risks they pose.
    On a related matter, the same question has been raised on 
we left a lot to the regulators, and, again, I am the first to 
admit exactly we did that, because, again, a set of proposed 
rules with commentary periods, all of the factors and processes 
we go through to determine how best to set these up. As someone 
who has been not only a student and a practitioner in all of 
this--and obviously a regulator, but aside from that, stepping 
back from the regulator role, was that generally the right 
approach in your view that we took with this matter rather than 
trying to write in a sense rigid standards in the legislation 
that would have, I think, been more constraining in terms of 
our ability to have a more measured response?
    Mr. Bernanke. On the specifics of capital there are some 
rules, the Collins amendment and so on. But it was very 
important that we have at least some flexibility in order to 
negotiate and collaborate with our international colleagues on 
developing an international set of capital standards. So that 
was very important.
    Inevitably in a bill this complex that is addressing so 
many complex issues, if you want it to be responsive to changes 
in the environment, to deal with a lot of technical details, I 
think inevitably the regulators have to play a role. But 
Congress certainly has an oversight role. You are certainly 
going to be seeing what we do, and if you are dissatisfied, I 
am sure you will let us know.
    Chairman Dodd. Well, in fact, I want to do that, but I am 
not going to set the hearing date today, but I want to put my 
colleagues on notice here that my view would be that even as 
early as September--again, on the assumption we will be leaving 
here in October for the elections, but in September at some 
point--I will give people enough time, so probably toward the 
end of the month, conduct a series of hearings, either one or 
two of them anyway, with yourself and others to come before us 
and more specifically lay out what steps exactly are being 
taken by the various regulators under the proposed legislation 
so we get some sense of where things are heading at that time. 
That may be helpful.
    In that regard, I just wanted to ask you, the financial 
reform bill creates the Financial Stability and Oversight 
Council, which you know, and the Office of Financial Research 
to provide it with data and analysis on overall financial 
market conditions. And I think particularly, despite the 
criticism of some, I think the Office of Financial Research 
will be a real asset for us in terms of that kind of real-time 
data that ought to be, I hope, of real assistance to you and 
others. But do you think that the macroprudential supervision 
of the economy can help to prevent a financial crisis in the 
future? And how do you foresee--and this may be the more 
important of the two questions. How do you foresee the 
interaction of macroprudential supervision with the traditional 
bank-by-bank microprudential supervision of banking regulators?
    Mr. Bernanke. Mr. Chairman, there has been some commentary 
which says that the bill relies too much on prescient or 
omnicompetent regulators to identify risks that are emerging. 
In fact, there are multiple aspects of this bill. First, there 
is the macroprudential aspect which asks the regulators to look 
for emerging risks.
    Chairman Dodd. Right.
    Mr. Bernanke. I think the regulators would have had a 
better chance of identifying some of the problems that arose in 
this recent crisis with that kind of framework that you have 
created. But beyond that macroprudential aspect, there is also 
a number of steps to strengthen the system, make it more 
resilient, to put more derivatives through central 
counterparties, to increase capital and so on, so that whatever 
the source of a future crisis, even if it is not identified and 
defused, the system will be better able to withstand that 
effect.
    And then, finally, if we get unfortunately to the 
firefighting stage, there are additional tools there. So I 
think it is a useful approach to have multiple ways of 
addressing crises, both preventive and resilience and 
firefighting.
    So the macroprudential part is very important. It is 
difficult. It is going to require coordination among different 
regulators, but it is a direction that regulators around the 
world and academics and others looking at this really believe 
is the right direction, and there is quite a bit of thinking 
already out there about how we could do, for example, stress 
tests that look at the whole system, which combine the results 
for individual firms, as you mentioned, but also are able to 
infer from that how the system as a whole might perform if a 
certain set of stresses arose.
    So there is clearly a relationship between the micro- and 
macroprudential part, but there is a lot of challenging work to 
be done there.
    Chairman Dodd. Well, I agree, and, again, you have already 
addressed this in passing, so I will leave it for a later 
gathering to look at all of this and how supervisory functions 
need to change under our legislation--I know you are giving a 
lot of thought to that already--as well as how we ought to 
handle the expanded mandates that we have saddled you with. 
And, again, I have a great deal of confidence it can be done, 
and I appreciate your response to Senator Bunning when he asked 
the question of whether or not you can do this. I am confident 
you can. Again, we have differences of opinions because I was 
looking at this a bit differently with more of a single 
prudential regulator where we sort of evolved from that back in 
November to what we have ended up here, and I accept that. That 
is how the process works here with people. I think even my 
views changed and were modified a bit as we went through the 
process. So I started out in one place. I would have been 
closer maybe to where I started out from than what we ended up, 
but, nonetheless, I accept the fact we are where we are and 
believe the capacity exists to get this right. And the fact 
that there is more of a holistic approach to this thing, where 
we have the capacity and the ability of talented people all 
driving toward the same goals, maintaining a strong, safe, and 
sound financial system with the kind of stability that is 
necessary in it, as well as restoring that level of trust and 
confidence in the system, which to me is the most critical 
element of all, that if the American people and others feel 
that sense of trust and confidence in our financial system, 
that in itself will have its own reward.
    So, again, I am very grateful to you and your staff and 
others for the tremendous amount of work you have put into this 
effort. I appreciate it very much. I look forward to getting 
together with you again in a couple of months here to really 
get down to the details of how this is going to work.
    Senator Shelby.
    Senator Shelby. Mr. Chairman, some observers warn of 
growing risk in the $2.8 trillion municipal debt market. Parts 
of California as well as municipalities in Illinois, Michigan, 
and New York seem to have been vulnerable to market-driven 
widening of spreads on their bonds relative to Treasuries, 
especially when market anxiety over fiscal conditions in the 
euro zone grew. I have two questions regarding municipal debt.
    What is your assessment of the state of the U.S. municipal 
debt markets? Second, do you believe there is any merit to a 
recent characterization by Warren Buffett that there is 
potentially ``a terrible problem'' ahead for municipal bonds?
    Mr. Bernanke. Well, first, it is certainly true that States 
and localities are under a lot of fiscal and financial stress. 
Their revenues have fallen considerably, and they are trying to 
maintain services and so on. So clearly we have seen some 
deficits and some cuts at the State and local level.
    My view is first of all that the municipal debt market is 
functioning pretty well, that at least States and localities 
that have good credit or seem to be sound are not having any 
difficulty accessing the municipal market, and that yields are 
pretty low, which is fortunate because there are a number of 
States and localities that are being forced to borrow under the 
current circumstances.
    Certainly there may be some localities in particular that 
will have trouble, but I would draw a distinction between say 
California and Greece, which is that because of these budget 
balance requirements, the outstanding debt of States is 
generally much less than the United States or other countries.
    So we always have to pay close attention, and there are a 
lot of stresses at the State and local level, but I do not at 
this point view the municipal debt market as being a major risk 
to the economy.
    Senator Shelby. Deflation and the Japanese experience, some 
people express fear that the U.S. could find itself in a period 
of deflation and, like Japan, have difficulty escaping. What do 
you believe are the differences between the U.S. and Japan in 
terms of structure of economic policy that would ensure that we 
do not follow the Japanese experience? And is that a concern of 
the Fed?
    Mr. Bernanke. Again, forecasts are very uncertain, but I do 
not view deflation as a near-term risk for the United States. 
If you look at inflation expectations as measured by Government 
bond markets or by surveys, there has not really been much 
decline in expected inflation, and that stability of inflation 
expectations is one important factor that will keep inflation 
from falling very much. So, again, the forecasts of the FOMC 
are for a gradual increase of inflation toward a more normal, 
say 2-percent level, and there is not at this point, a very 
high probability that deflation will become a concern.
    I think there are very important differences between the 
U.S. and Japan. Some of them are structural. The Japanese 
economy has been relatively low productivity in recent years. 
It has got a declining labor force, and so its potential growth 
rate is lower than the U.S., and it has been a less vibrant 
economy in that respect. Also in Japan are much longer-lived 
problems with their banking system, which were not addressed 
for some years. For better or worse, we were very aggressive in 
addressing our banking system issues, and I think, as I 
mentioned to a couple of folks our system is strengthening and 
looks to be doing much better. So I do not think that will be a 
source of long-term drag either.
    And, finally, I would comment that I think the Federal 
reserve does have the capacity, the tools, should deflation 
occur--which I do not believe is very likely--to reverse it, 
and we would be assiduous in doing that.
    So I do not consider this to be a very high risk at this 
point, but, of course, we will continue to monitor the economy 
and the price level.
    Chairman Dodd. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman, and, Mr. Chairman, 
I thank you for your testimony and coming here today. And I 
know there has been a lot of probings about monetary policy, 
and I very much appreciate the fact that you stayed consistent 
with your report. So I want to probe in another area, and that 
is, Senator Brown was pursuing the whole issue of China, and I 
do think that--and I know you said we should focus on the 
overall trade deficits, not the bilateral deficits. But I do 
think with the economy being as it is and just the relationship 
as it is, there may be attempts to try to deal with that 
legislatively. I do not know. And I just wondered if you would 
share with us the fact is--I mean, you did say it is a subsidy, 
and it is, to the Chinese people to have a currency valuation 
relative to the dollar that allows them to export to us.
    What are the things that all of us who want to make sure we 
try to do good things, what are the things we should think 
about as it relates to the Chinese currency? And what are some 
of the unintended consequences we should also be aware of?
    Mr. Bernanke. Of the----
    Senator Corker. Well, I mean, there are people looking at--
there are all kind of things, and I understand, especially 
folks who come from textile orientations and all of that. I 
know Chuck Schumer and Lindsey Graham have looked at some 
things. I think there is going to be a push. I just think as 
this economy moves along slowly and that trade gap widens, I 
think there may be some legislative efforts to deal with that. 
I am not saying I am going to be a part of that or not part of 
that, but what are the things that as legislators we should 
think about as it relates to that issue and some of the 
unintended consequences of dealing with it inappropriately?
    Mr. Bernanke. Well, I fully understand the concern, and 
again, it is felt more probably in specific industries than it 
is for the economy as a whole or for employment as a whole.
    Senator Corker. Say that again? I did not hear it.
    Mr. Bernanke. I understand the concern. I think that as 
Senator Brown was pointing out, it is easier to identify 
effects on specific industries than it is to find effects of 
the currency policy on the economy as a whole or unemployment 
as a whole, because there is not much relationship between our 
unemployment rate and our current account deficit.
    Just to take an obvious example, unemployment has soared 
recently while the current account deficit has actually come 
down. But I do understand the concern.
    All I can really say is that to take some of the steps that 
have been suggested would be quite severe steps and would cause 
considerable concern about our overall relationship with China 
and other countries and about our trading policies.
    Again, I understand the concern, but I would just reiterate 
first that this is a complex problem and that it is not just 
the currency that is involved. The Chinese are also involved in 
trying to restructure their economy to become more reliant on 
domestic demand, first of all. Second, I would note that the 
United States has got a vibrant bilateral relationship in terms 
of our dialog, for example, the strategic and economic dialog 
which has been going on was created by Secretary Paulson, has 
been expanded and continued by the current administration. And 
one of the things that is evident from that is that the U.S. 
and China have a wide range of issues, not just the currency 
but a wide range of issues relating to energy and environment 
and tourism and investment and trade and many other things 
where we have common interests, where we need to work 
cooperatively together. So I hope that Congress will think very 
carefully before taking any strong action.
    At the same time, I recognize that particularly the 
Treasury has a special role here because they are the spokesman 
for the currency, but for the Federal Reserve as well to try to 
maintain a constant dialogue to persuade the Chinese and to 
apply pressure to them that they need to adjust their currency, 
which is their current policy distorts capital flows globally, 
but it is not even good for China in the longer term. It 
distorts their economy as well and makes them too reliant on 
exports and reduces their own domestic consumption and also 
makes their monetary policy less independent. So there are a 
lot of costs to them as well, and we are hopeful that they have 
become more appreciative of those concerns over time.
    Senator Corker. In most recent statements that they made, 
they gave a tilt, if you will, prior to some G-20 meetings, as 
to what they may be doing. What do you read into that? And what 
is your sense as you talk to counterparts about what their 
longer-term efforts will be?
    Mr. Bernanke. With respect to the currency?
    Senator Corker. Yes.
    Mr. Bernanke. Well, as you know, they have gone back to the 
managed float which allows for small changes in the currency. I 
think that the amount that they let it move will depend on 
their own views of the stability of their own economy and 
global growth. We are going to have to see. I honestly do not 
know exactly what their plans are. I suspect that they will be 
responding to how they view the evolution of global economic 
conditions.
    Senator Corker. Well, Mr. Chairman, I thank you for coming 
and certainly look forward to talking to you about those issues 
going down the road. We had a good hearing yesterday that 
Senator Bayh chaired, and I think in any bill that passes there 
are good things and bad things, and people have to make 
decisions about how they voted based on the net effect.
    I do think that all of us are hopeful that as it relates to 
our relations with the other countries, we end up with a 
regulatory regime that works well for all of us, and I wish you 
well in those efforts and look forward to talking to you as you 
move ahead. Thank you.
    Mr. Bernanke. Thank you, Senator.
    Chairman Dodd. Thank you
    Let me ask, Mr. Chairman--and, again, this goes to the same 
sort of question that Senator Corker has raised. Some have 
suggested that we would have been better off had we not acted 
in this area of financial reform, that if we had just let the 
market continue the status quo. In fact, some have even 
suggested that given the opportunity they would like to repeal 
this effort we have all gone through over the last year and a 
half.
    Assuming that what you are talking about is repealed is 
basically going back to the status quo, are we better off, in 
your view, with this legislation--I know a lot of work needs to 
be done--than we would be if we would have just maintained the 
status quo as things were prior to the passage of this 
legislation?
    Mr. Bernanke. Yes, I think we are. I think there were 
important gaps in our regulatory system which became painfully 
evident during the crisis and that substantial progress has 
been made to closing those gaps. We have increased our capacity 
to take a macroprudential approach, which I think is an 
important complement to our current institution-by-institution 
approach. And the ability to wind down large firms and avoid 
the bailout problem or avoid the situation where we have to 
choose between a bailout and a financial crisis, I think that 
is an important step also.
    Now, all those things are going to require a lot of work to 
make them effective and useful tools, but it was very important 
to address those problems.
    Chairman Dodd. And so, therefore, it would be imprudent to 
repeal what we have talked about, what we have done here?
    Mr. Bernanke. No, I would not support repeal.
    Chairman Dodd. Thank you very much. This Committee will 
stand adjourned. Thank you, Mr. Chairman.
    Mr. Bernanke. Thank you.
    [Whereupon, at 4:37 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]

                 PREPARED STATEMENT OF BEN S. BERNANKE
       Chairman, Board of Governors of the Federal Reserve System
                             July 21, 2010

    Chairman Dodd, Senator Shelby, and Members of the Committee, I am 
pleased to present the Federal Reserve's semiannual Monetary Policy 
Report to the Congress.
Economic and Financial Developments
    The economic expansion that began in the middle of last year is 
proceeding at a moderate pace, supported by stimulative monetary and 
fiscal policies. Although fiscal policy and inventory restocking will 
likely be providing less impetus to the recovery than they have in 
recent quarters, rising demand from households and businesses should 
help sustain growth. In particular, real consumer spending appears to 
have expanded at about a 2\1/2\ percent annual rate in the first half 
of this year, with purchases of durable goods increasing especially 
rapidly. However, the housing market remains weak, with the overhang of 
vacant or foreclosed houses weighing on home prices and construction.
    An important drag on household spending is the slow recovery in the 
labor market and the attendant uncertainty about job prospects. After 2 
years of job losses, private payrolls expanded at an average of about 
100,000 per month during the first half of this year, a pace 
insufficient to reduce the unemployment rate materially. In all 
likelihood, a significant amount of time will be required to restore 
the nearly 8\1/2\ million jobs that were lost over 2008 and 2009. 
Moreover, nearly half of the unemployed have been out of work for 
longer than 6 months. Long-term unemployment not only imposes 
exceptional near-term hardships on workers and their families, it also 
erodes skills and may have long-lasting effects on workers' employment 
and earnings prospects.
    In the business sector, investment in equipment and software 
appears to have increased rapidly in the first half of the year, in 
part reflecting capital outlays that had been deferred during the 
downturn and the need of many businesses to replace aging equipment. In 
contrast, spending on nonresidential structures--weighed down by high 
vacancy rates and tight credit--has continued to contract, though some 
indicators suggest that the rate of decline may be slowing. Both U.S. 
exports and U.S. imports have been expanding, reflecting growth in the 
global economy and the recovery of world trade. Stronger exports have 
in turn helped foster growth in the U.S. manufacturing sector.
    Inflation has remained low. The price index for personal 
consumption expenditures appears to have risen at an annual rate of 
less than 1 percent in the first half of the year. Although overall 
inflation has fluctuated, partly reflecting changes in energy prices, 
by a number of measures underlying inflation has trended down over the 
past 2 years. The slack in labor and product markets has damped wage 
and price pressures, and rapid increases in productivity have further 
reduced producers' unit labor costs.
    My colleagues on the Federal Open Market Committee (FOMC) and I 
expect continued moderate growth, a gradual decline in the unemployment 
rate, and subdued inflation over the next several years. In conjunction 
with the June FOMC meeting, Board members and Reserve Bank presidents 
prepared forecasts of economic growth, unemployment, and inflation for 
the years 2010 through 2012 and over the longer run. The forecasts are 
qualitatively similar to those we released in February and May, 
although progress in reducing unemployment is now expected to be 
somewhat slower than we previously projected, and near-term inflation 
now looks likely to be a little lower. Most FOMC participants expect 
real GDP growth of 3 to 3\1/2\ percent in 2010, and roughly 3\1/2\ to 
4\1/2\ percent in 2011 and 2012. The unemployment rate is expected to 
decline to between 7 and 7\1/2\ percent by the end of 2012. Most 
participants viewed uncertainty about the outlook for growth and 
unemployment as greater than normal, and the majority saw the risks to 
growth as weighted to the downside. Most participants projected that 
inflation will average only about 1 percent in 2010 and that it will 
remain low during 2011 and 2012, with the risks to the inflation 
outlook roughly balanced.
    One factor underlying the Committee's somewhat weaker outlook is 
that financial conditions--though much improved since the depth of the 
financial crisis--have become less supportive of economic growth in 
recent months. Notably, concerns about the ability of Greece and a 
number of other euro-area countries to manage their sizable budget 
deficits and high levels of public debt spurred a broad-based 
withdrawal from risk-taking in global financial markets in the spring, 
resulting in lower stock prices and wider risk spreads in the United 
States. In response to these fiscal pressures, European leaders put in 
place a number of strong measures, including an assistance package for 
Greece and =500 billion of funding to backstop the near-term financing 
needs of euro-area countries. To help ease strains in U.S. dollar 
funding markets, the Federal Reserve reestablished temporary dollar 
liquidity swap lines with the ECB and several other major central 
banks. To date, drawings under the swap lines have been limited, but we 
believe that the existence of these lines has increased confidence in 
dollar funding markets, helping to maintain credit availability in our 
own financial system.
    Like financial conditions generally, the state of the U.S. banking 
system has also improved significantly since the worst of the crisis. 
Loss rates on most types of loans seem to be peaking, and, in the 
aggregate, bank capital ratios have risen to new highs. However, many 
banks continue to have a large volume of troubled loans on their books, 
and bank lending standards remain tight. With credit demand weak and 
with banks writing down problem credits, bank loans outstanding have 
continued to contract. Small businesses, which depend importantly on 
bank credit, have been particularly hard hit. At the Federal Reserve, 
we have been working to facilitate the flow of funds to creditworthy 
small businesses. Along with the other supervisory agencies, we issued 
guidance to banks and examiners emphasizing that lenders should do all 
they can to meet the needs of creditworthy borrowers, including small 
businesses. \1\ We also have conducted extensive training programs for 
our bank examiners, with the message that lending to viable small 
businesses is good for the safety and soundness of our banking system 
as well as for our economy. We continue to seek feedback from both 
banks and potential borrowers about credit conditions. For example, 
over the past 6 months we have convened more than 40 meetings around 
the country of lenders, small business representatives, bank examiners, 
government officials, and other stakeholders to exchange ideas about 
the challenges faced by small businesses, particularly in obtaining 
credit. A capstone conference on addressing the credit needs of small 
businesses was held at the Board of Governors in Washington last week. 
\2\ This testimony includes an addendum that summarizes the findings of 
this effort and possible next steps.
---------------------------------------------------------------------------
     \1\ See Board of Governors of the Federal Reserve System, Federal 
Deposit Insurance Corporation, National Credit Union Administration, 
Office of the Comptroller of the Currency, Office of Thrift 
Supervision, and Conference of State Bank Supervisors (2010), 
``Regulators Issue Statement on Lending to Creditworthy Small 
Businesses'', joint press release, February 5, www.federalreserve.gov/
newsevents/press/bcreg/20100205a.htm.
     \2\ For more information, see Ben S. Bernanke (2010), ``Restoring 
the Flow of Credit to Small Businesses'', speech delivered at 
``Addressing the Financing Needs of Small Businesses,'' a forum 
sponsored by the Federal Reserve Board, Washington, July 12, 
www.federalreserve.gov/newsevents/speech/bernanke20100712a.htm.
---------------------------------------------------------------------------
Federal Reserve Policy
    The Federal Reserve's response to the financial crisis and the 
recession has involved several components. First, in response to the 
periods of intense illiquidity and dysfunction in financial markets 
that characterized the crisis, the Federal Reserve undertook a range of 
measures and set up emergency programs designed to provide liquidity to 
financial institutions and markets in the form of fully secured, mostly 
short-term loans. Over time, these programs helped to stem the panic 
and to restore normal functioning in a number of key financial markets, 
supporting the flow of credit to the economy. As financial markets 
stabilized, the Federal Reserve shut down most of these programs during 
the first half of this year and took steps to normalize the terms on 
which it lends to depository institutions. The only such programs 
currently open to provide new liquidity are the recently reestablished 
dollar liquidity swap lines with major central banks that I noted 
earlier. Importantly, our broad-based programs achieved their intended 
purposes with no loss to taxpayers. All of the loans extended through 
the multiborrower facilities that have come due have been repaid in 
full, with interest. In addition, the Board does not expect the Federal 
Reserve to incur a net loss on any of the secured loans provided during 
the crisis to help prevent the disorderly failure of systemically 
significant financial institutions.
    A second major component of the Federal Reserve's response to the 
financial crisis and recession has involved both standard and less 
conventional forms of monetary policy. Over the course of the crisis, 
the FOMC aggressively reduced its target for the Federal funds rate to 
a range of 0 to \1/4\ percent, which has been maintained since the end 
of 2008. And, as indicated in the statement released after the June 
meeting, 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. \3\
---------------------------------------------------------------------------
     \3\ See, Federal Reserve Board of Governors (2010), ``FOMC 
Statement'', press release, June 23, www.federalreserve.gov/newsevents/
press/monetary/20100623a.htm.
---------------------------------------------------------------------------
    In addition to the very low Federal funds rate, the FOMC has 
provided monetary policy stimulus through large-scale purchases of 
longer-term Treasury debt, Federal agency debt, and agency mortgage-
backed securities (MBS). A range of evidence suggests that these 
purchases helped improve conditions in mortgage markets and other 
private credit markets and put downward pressure on longer-term private 
borrowing rates and spreads.
    Compared with the period just before the financial crisis, the 
System's portfolio of domestic securities has increased from about $800 
billion to $2 trillion and has shifted from consisting of 100 percent 
Treasury securities to having almost two-thirds of its investments in 
agency-related securities. In addition, the average maturity of the 
Treasury portfolio nearly doubled, from 3\1/2\ years to almost 7 years. 
The FOMC plans to return the System's portfolio to a more normal size 
and composition over the longer term, and the Committee has been 
discussing alternative approaches to accomplish that objective.
    One approach is for the Committee to adjust its reinvestment 
policy--that is, its policy for handling repayments of principal on the 
securities--to gradually normalize the portfolio over time. Currently, 
repayments of principal from agency debt and MBS are not being 
reinvested, allowing the holdings of those securities to run off as the 
repayments are received. By contrast, the proceeds from maturing 
Treasury securities are being reinvested in new issues of Treasury 
securities with similar maturities. At some point, the Committee may 
want to shift its reinvestment of the proceeds from maturing Treasury 
securities to shorter-term issues, so as to gradually reduce the 
average maturity of our Treasury holdings toward precrisis levels, 
while leaving the aggregate value of those holdings unchanged. At this 
juncture, however, no decision to change reinvestment policy has been 
made.
    A second way to normalize the size and composition of the Federal 
Reserve's securities portfolio would be to sell some holdings of agency 
debt and MBS. Selling agency securities, rather than simply letting 
them run off, would shrink the portfolio and return it to a composition 
of all Treasury securities more quickly. FOMC participants broadly 
agree that sales of agency-related securities should eventually be used 
as part of the strategy to normalize the portfolio. Such sales will be 
implemented in accordance with a framework communicated well in advance 
and will be conducted at a gradual pace. Because changes in the size 
and composition of the portfolio could affect financial conditions, 
however, any decisions regarding the commencement or pace of asset 
sales will be made in light of the Committee's evaluation of the 
outlook for employment and inflation.
    As I noted earlier, the FOMC continues to anticipate that economic 
conditions are likely to warrant exceptionally low levels of the 
Federal funds rate for an extended period. At some point, however, the 
Committee will need to begin to remove monetary policy accommodation to 
prevent the buildup of inflationary pressures. When that time comes, 
the Federal Reserve will act to increase short-term interest rates by 
raising the interest rate it pays on reserve balances that depository 
institutions hold at Federal Reserve Banks. To tighten the linkage 
between the interest rate paid on reserves and other short-term market 
interest rates, the Federal Reserve may also drain reserves from the 
banking system. Two tools for draining reserves from the system are 
being developed and tested and will be ready when needed. First, the 
Federal Reserve is putting in place the capacity to conduct large 
reverse repurchase agreements with an expanded set of counterparties. 
Second, the Federal Reserve has tested a term deposit facility, under 
which instruments similar to the certificates of deposit that banks 
offer their customers will be auctioned to depository institutions.
    Of course, even as the Federal Reserve continues prudent planning 
for the ultimate withdrawal of extraordinary monetary policy 
accommodation, we also recognize that the economic outlook remains 
unusually uncertain. We will continue to carefully assess ongoing 
financial and economic developments, and we remain prepared to take 
further policy actions as needed to foster a return to full utilization 
of our Nation's productive potential in a context of price stability.
Financial Reform Legislation
    Last week, the Congress passed landmark legislation to reform the 
financial system and financial regulation, and the President signed the 
bill into law this morning. That legislation represents significant 
progress toward reducing the likelihood of future financial crises and 
strengthening the capacity of financial regulators to respond to risks 
that may emerge. Importantly, the legislation encourages an approach to 
supervision designed to foster the stability of the financial system as 
a whole as well as the safety and soundness of individual institutions. 
Within the Federal Reserve, we have already taken steps to strengthen 
our analysis and supervision of the financial system and systemically 
important financial firms in ways consistent with the new legislation. 
In particular, making full use of the Federal Reserve's broad expertise 
in economics, financial markets, payment systems, and bank supervision, 
we have significantly changed our supervisory framework to improve our 
consolidated supervision of large, complex bank holding companies, and 
we are enhancing the tools we use to monitor the financial sector and 
to identify potential systemic risks. In addition, the briefings 
prepared for meetings of the FOMC are now providing increased coverage 
and analysis of potential risks to the financial system, thus 
supporting the Federal Reserve's ability to make effective monetary 
policy and to enhance financial stability.
    Much work remains to be done, both to implement through regulation 
the extensive provisions of the new legislation and to develop the 
macroprudential approach called for by the Congress. However, I believe 
that the legislation, together with stronger regulatory standards for 
bank capital and liquidity now being developed, will place our 
financial system on a sounder foundation and minimize the risk of a 
repetition of the devastating events of the past 3 years.
    Thank you. I would be pleased to respond to your questions.

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

Q.1. Effect of Stimulus--The economy has been growing for 
several quarters now, but that growth has been significantly 
boosted by tax cuts and government spending under the Recovery 
Act. Economists think the boost was as much as 2\1/2\ 
percentage points and the Council of Economic Advisors last 
week estimated that Recovery Act programs created and saved 2.5 
to 3.6 million jobs.
    It's always hard to speculate on counterfactual scenarios, 
but how much do you think the Recovery Act programs--tax cuts 
and spending--have boosted GDP growth so far?
    What do you think the state of our economy, including the 
unemployment rate, would be right now if we hadn't passed the 
stimulus bill?

A.1. As noted by your question, it is difficult to confidently 
determine the effects of the 2009 American Recovery and 
Reinvestment Act (ARRA) on economic activity. In particular, it 
is not possible to establish with certainty the counterfactual 
of what households and State and local governments would have 
spent in the absence of receiving stimulus funds. That said, 
the available economic evidence suggests that the tax 
reductions and increases in transfers for households have 
likely provided support to consumer spending--relative to what 
it would have been otherwise--as households, since the 
enactment of the ARRA, have faced sluggish income growth, an 
extremely weak labor market, losses in wealth, and tight credit 
conditions. Also, the stimulus grants for states and localities 
appear to have helped these governments maintain their 
spending--relative to what it would have been otherwise--in the 
face of very weak tax receipts. The Congressional Budget Office 
(CBO) has provided what I think is a reasonable range of 
estimates of the effects of the ARRA on macroeconomic activity. 
The CBO's estimates suggest that the ARRA boosted the rate of 
change in real GDP by between 1\1/2\ and 3\1/2\ percentage 
points last year and added around \1/4\ to 1 percentage point 
to real GDP growth in the first half of this year; the 
unemployment rate is estimated to have been reduced by between 
\3/4\ and 2 percentage points by the middle of this year.
    The fiscal policy actions taken to address the 
extraordinary challenges imposed by the recent recession and 
the financial crisis have contributed to significantly wider 
Federal deficits since last year. These actions were necessary 
to help mitigate the overall loss of employment and income that 
otherwise would have occurred thereby laying the groundwork for 
a self-sustaining, broad-based recovery. But maintaining the 
confidence of the financial markets and the public requires 
that plans now begin to be put into place for the restoration 
of fiscal balance in the medium term in order to avoid the 
economic costs and risks associated with persistently large 
deficits that cause the Federal debt to expand significantly 
faster than the economy.
                                ------                                


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

Q.1. Back in December 2006, during the U.S.-China Strategic 
dialogue, you described China's undervalued currency as ``an 
effective subsidy for Chinese exporters.'' During your 
testimony you confirmed that you believe this to still be the 
case. Do you agree with many economists that the subsidy 
approaches 40 percent? If not, what is the price subsidy range, 
and what evidence are you using to support this conclusion?

A.1. This note briefly summarizes the professional literature 
that seeks to assess the undervaluation of the Chinese renminbi 
(RMB). While this literature has generated an array of 
estimates, most studies put the extent of this undervaluation 
in the range of roughly 10 percent to 30 percent.
    For many reasons, when discussing currency misalignments 
and their implications for current account balances, economists 
generally prefer to focus on the behavior of the real effective 
exchange rate (which takes into account the value of a 
country's currency against the currencies of all of its trading 
partners and adjusts for cross-country differences in rates of 
inflation) rather than on bilateral nominal exchange rates. The 
estimates reported here, therefore, focus on the extent of 
undervaluation of the real effective Chinese exchange rate, 
rather than of the nominal value of the RMB vis-a-vis the 
dollar.
    There is no single accepted methodology for determining 
whether a country's exchange rate is appropriately valued. 
Studies have employed a variety of approaches to measure a 
currency's misalignment, including the following:

    One approach seeks to estimate how far the real 
        effective exchange rate is from the level that would 
        ensure a sustainable current account balance over the 
        medium term.

    Another approach aims to estimate how out of line a 
        country's real effective exchange rate is compared with 
        those of other countries, taking into account the 
        country's level of development, income, and other 
        macroeconomic and financial considerations.

    Yet a third approach attempts to gauge how far a 
        country's real effective exchange rate is from the 
        level that would be necessary to stabilize the 
        country's net creditor position at a reasonable level 
        relative to the size of its GDP.

    Using these approaches, researchers have found a wide range 
of estimates for the extent of undervaluation of the Chinese 
RMB. There are some outlier estimates that put the Chinese 
currency at being even 5 percent overvalued and, at the other 
extreme, at as much as 60 percent undervalued. The bulk of the 
studies, however, fall in the range of 10 percent to 30 
percent, undervaluation. For example, a very recent study, 
Cline and Williamson (2010), follows the first approach 
described above and obtains the result that the RMB is 
approximately 15 percent undervalued. \1\ Cline and Williamson 
arrive at this result by assuming China's sustainable (or 
``target'') current account surplus to be about 3 percent of 
GDP and using a forecasted value of the current account surplus 
in the absence of any exchange rate adjustment of about 7.5 
percent of GDP. \2\ They then estimate that the amount of real 
effective appreciation of the RMB that would be necessary to 
move the current account from 7.5 percent of GDP to 3 percent 
of GDP is about 15 percent. \3\
---------------------------------------------------------------------------
     \1\ William R. Cline and John Williamson, ``Estimates of 
Fundamental Equilibrium Exchange Rates, May 2010'', Peterson Institute 
for International Economics, Policy Brief Number PB10-15.
     \2\ They take the forecasted value of China's current account from 
the International Monetary Fund's World Economic Outlook, April 2010 
with some adjustments.
     \3\ Last year, when the IMF was forecasting a bigger medium-term 
current account surplus for China, Cline and Williamson's estimate of 
the degree of undervaluation of the real effective RMB was a little 
over 20 percent.
---------------------------------------------------------------------------
    Another study, Goldstein (2007), finds that ``the RMB is 
now grossly undervalued--on the order of 30 percent or more 
against an average of China's trading partners.'' \4\ However, 
this finding uses data that go only through 2006. Generally, 
estimates using more recent data find a somewhat smaller degree 
of undervaluation. The IMF staff has also determined that the 
``renminbi remains substantially below the level that is 
consistent with medium-term fundamentals.'' \5\ Clearly, these 
estimates and other estimates in this literature are quite 
sensitive to a number of underlying assumptions about which 
there is often not much consensus, as well as to the approaches 
used to compute the undervaluation and the exact vintage of 
Chinese data used in the analysis.
---------------------------------------------------------------------------
     \4\ Morris Goldstein, ``A (Lack of) Progress Report on China's 
Exchange Rate Policies'', Peterson Institute for International 
Economics, Working Paper 07-5. This study updates results from Morris 
Goldstein and Nicholas Lardy, ``China's Exchange Rate Policy Dilemma'', 
American Economic Review, Vol. 96, No. 2 (May, 2006), pp. 422-426, 
which provides more details of the methodology used.
     \5\ ``People's Republic of China: 2010 Article IV Consultation'', 
International Monetary Fund, IMF Country Report No. 10/238, July 2010.
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                                ------                                


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

Q.1. In the past months, the European Central Bank has spent 
billions of dollars to purchase sovereign debt from 
overleveraged EU countries, in essence bailing out these 
countries by supporting their ability to continue to finance 
further debt rather than impose needed budgetary discipline. 
Prior to this program, the ECB, through liquidity facilities, 
was accepting sovereign debt collateral from European banks. 
Here at home in the U.S., some States and municipalities have 
similarly overleveraged themselves and failed to make the 
difficult decisions necessary to get their finances in order--
the clearest example being the States of Illinois and 
California. Being concerned that the Federal Reserve could 
choose to pursue a similar course, is it your opinion that the 
Fed has the authority:

    a. To accept municipal debt as collateral from commercial 
or investment banks?

    b. To create a special lending facility for private-sector 
purchases of municipal bonds, similar to what the Fed did in 
2009 for commercial real estate securitizations?

    c. To guarantee or directly purchase municipal bonds in the 
secondary market, similar to the purchase program for the more 
than $1 trillion of mortgage-backed securities now on the Fed's 
balance sheet?

    d. To lend directly to overleveraged States or 
municipalities?

A.1. Answer not received by time of publication.

Q.2. If your answer to any of Question Number 1's subparts is 
yes, please explain, for each and with specific references, 
from where this authority is derived?

A.2. Answer not received by time of publication.

Q.3. Would you ever support any of the following courses of 
action for the Federal Reserve:

    a. To accept municipal debt as collateral from commercial 
or investment banks?

    b. To create a special lending facility for private-sector 
purchases of municipal bonds, similar to what the Fed did in 
2009 for commercial real estate securitizations?

    c. To guarantee or directly purchase municipal bonds in the 
secondary market, similar to the purchase program for the more 
than $1 trillion of mortgage-backed securities now on the Fed's 
balance sheet?

    d. To lend directly to overleveraged States or 
municipalities?

A.3. Answer not received by time of publication.

Q.4. If your answer to any of Question Number 3's subparts is 
yes, please explain your rationale for each.

A.4. Answer not received by time of publication.

                                ------                                


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

Q.1. Chairman Bernanke, I am deeply disturbed by the most 
recent quarterly report to Congress from the Special Inspector 
General for the Troubled Asset Relief Program. In this report, 
SIGTARP Neil Barofsky tells Congress that reductions in current 
outstanding balances of TARP and TARP-related programs ``have 
been more than offset in the past 12 months by significant 
increases in expenditures and guarantees in other programs, 
with the total current outstanding balance increasing 23 
percent, from approximately $3.0 trillion to $3.7 trillion. 
This increase can largely be attributed to great support for 
the Government-sponsored enterprises (GSEs), the housing 
market, and the financial institutions that participate in it'' 
despite the fact that the banking crisis, by an reasonable 
measures, subsided. How long do you perceive a need for 
extraordinary taxpayer support for the housing market?

A.1. As your question suggests, declining balances in, and 
closing of, some financial-sector support programs are positive 
developments that are indicative of a gradual healing in the 
financial system. The stock of other assets acquired by the 
Federal Government related to extraordinary support of the 
financial system has increased significantly over the past 
year, including purchases of Treasury, agency, and agency-
guaranteed mortgage-backed securities under the Federal 
Reserve's large scale asset purchase program, and purchases by 
Treasury of preferred shares in Fannie Mae and Freddie Mac as 
those GSEs continue to operate in conservatorship. Other 
housing-related guarantees, commitments, and outlays by the 
Government have also grown significantly over that period, 
although some are probably better understood as reflecting 
extraordinary conditions in the housing finance market more 
than extraordinary actions to support the financial system. In 
particular, mortgage loans and mortgage-backed securities 
guaranteed by FRA and the GSEs have continued to rise 
substantially, as the private-label mortgage securitization 
market remained essentially closed.
    The programs described above, along with continuing low 
mortgage interest rates and the effects of the first-time 
homebuyer tax credit, have helped support housing market 
conditions and thus to blunt some of the damage of the 
financial crisis. Nonetheless underlying weaknesses remain in 
the housing and home finance markets. As noted in my testimony, 
for example, housing construction has continued to be weighed 
down by weak demand, a large inventory of distressed or vacant 
houses, and tight credit conditions for builders and some 
potential buyers. For their part, RAMP and non-RAMP foreclosure 
mitigation loan modification programs have made a positive 
contribution, reducing debt service obligations for many 
struggling borrowers. Over the longer horizon, it remains too 
early to assess the overall effect of these programs, including 
the extent to which borrowers with RAMP permanent 
modifications, or other loan modifications and refinancings, 
may subsequently default on these obligations.
    As economic and financial conditions gradually improve, the 
extraordinary conditions and need for extraordinary Government 
actions will of course diminish. When that time comes, as with 
the Federal Reserve's purchases of agency-guaranteed mortgage-
backed securities, the withdrawal of extraordinary support 
should be managed carefully so that it can be achieved with a 
minimum of associated dislocation. Congress has a direct/public 
policy role to play in some aspects of this eventual 
withdrawal, including as it considers the future role of 
Government-sponsored enterprises in the market for housing 
finance.
    The non-TARP program estimates published in SIGTARP reports 
are assembled directly by SIGTARP staff across non-TARP 
programs they deem relevant, drawn from public sources. Without 
speaking directly to the figures you reference, the SIGTARP 
estimates cited in your question can reasonably be interpreted 
as consistent with this assessment.

Q.2. Chairman Bernanke, you have indicated that the Federal 
Reserve may undertake additional asset purchases. What kind of 
assets will the Fed purchase if it decides to undertake a 
second quantitative easing? How will you ensure that the 
Federal Reserve adequately protects itself in pricing those 
asset purchases and how long would the Fed hold those assets on 
its balance sheet? What metric will you use to determine that 
additional easing is necessary?

A.2. Consistent with its statutory mandate to foster maximum 
employment and stable prices, the Federal Reserve would 
consider additional steps to provide monetary accommodation if 
economic developments suggested that it was appropriate to do 
so. As noted in the minutes of recent FOMC meetings and in 
speeches by Federal Reserve officials, purchasing additional 
assets would be one of the options that the Federal Reserve 
could implement in such a situation. The Federal Reserve's 
legal authority largely limits Federal Reserve purchases of 
securities to Treasury, agency, and agency-guaranteed 
securities. As a result, additional Federal Reserve purchases 
of securities, if deemed necessary, would likely be of these 
general types. Decisions about the specific securities that 
would be purchased within this general class of securities 
would depend on a number of factors, including the implications 
of purchases for the general level of longer-term interest 
rates, the effect of purchases on market liquidity and 
functioning, and policymakers' preferences for the long-run 
composition of the Federal Reserve's balance sheet. As in the 
past, the Federal Reserve would employ a competitive bidding 
process in purchasing securities to ensure that such purchases 
are conducted at market prices.
    The evidence suggests that the Fed's earlier program of 
purchases of securities was effective in improving market 
functioning and lowering long-term interest rates in a number 
of private credit markets. The program (which was significantly 
expanded in March 2009) made an important contribution to the 
economic stabilization and recovery that began in the spring of 
2009. Indeed, the FOMC's recent decision to keep constant the 
Federal Reserve's securities holdings reflects the conviction 
that these holdings can promote financial conditions that help 
support the recovery. Decisions regarding how long these assets 
or any newly acquired assets will be held on the Federal 
Reserve's balance sheet will be based on an assessment of the 
outlook for economic activity and inflation.
    There are no simple metrics that the Federal Reserve can 
employ in determining whether additional policy easing is 
necessary and, if so, whether additional purchases of 
securities would be appropriate. As always, a wide range of 
economic indicators informs the Federal Reserve's view about 
the outlook for economic activity and inflation. Any decision 
to acquire additional securities would need to weigh the 
potential benefits of such purchases against the potential 
costs. Regarding potential benefits, additional purchases could 
further lower the costs of borrowing for households and 
businesses and thereby provide needed support for spending and 
economic growth. On the other hand, further purchases of 
securities could reduce public confidence in the ability of the 
Federal Reserve to exit smoothly from a very accommodative 
policy stance at the appropriate time. Even if unjustified, a 
reduction in confidence might lead to an undesired increase in 
inflation expectations and so to upward pressure on actual 
inflation. The Federal Reserve will weigh these and other 
considerations and carefully monitor economic and financial 
developments in judging whether additional asset purchases are 
warranted.

Q.3. A number of economists, market watchers and Members of 
Congress have speculated that U.S. firms are reluctant to 
invest and hire, though they may have the cash on their balance 
sheets to do so, because of uncertainty over a dramatic 
reshaping of the health care and financial regulatory regimes. 
How large of a role do you believe this uncertainty is playing 
in companies' decisions on how and when to deploy their 
capital? And, do you think the uncertainty over future tax 
rates also factors in?

A.3. Several factors are likely to influence hiring and capital 
spending decisions. Typically, a firm's sales prospects and the 
expected rate of return to an investment--either in new 
equipment or new workers--are key elements in the decision. In 
some cases, access to credit also might affect decisions to 
invest and hire. In addition, uncertainty about the economic 
environment or expected returns can also influence the 
willingness of a firm to make spending commitments.
    Recent surveys of businesses provide some insights into 
these issues and suggest that many firms are concerned about 
the overall economic environment and their company's own sales 
prospects. Two examples are presented in the table. As shown on 
line 1, 36 percent of respondents to the latest Duke CFO survey 
cited consumer demand as the most important problem facing 
their business. Fortunately, concerns about consumer demand 
have diminished from a year ago, but they remain the most 
frequently cited problem. Similarly, as shown on line 3 of the 
table, respondents to the latest survey of small businesses, 
conducted by the National Federation of Independent Business 
(NFIB), pointed to poor sales as their most important problem, 
but that concern also has diminished from a year ago. In 
addition, the S&P 500 volatility index (VIX), an indicator of 
uncertainty in financial markets, also is down from its 
previous peaks, although it remains relatively elevated by 
historical standards.


    It is difficult to know the extent to which uncertainty 
specifically related to future taxes, the recently enacted 
health care legislation, or financial regulatory reform is 
affecting business capital spending and hiring decisions. 
However, both the Duke CFO survey and the NFIB allow 
respondents to cite government policies more generally as the 
most important problem facing their business. These responses 
are shown on lines 2 and 4 of the table. In addition, line 5 
presents the data on the extent to which taxes are a pressing 
business concern. Of course, these responses are not direct 
indicators of uncertainty. Moreover, the figures presented in 
the table are from only two surveys and may not present a 
complete picture of whether greater uncertainty about 
Government policies is restraining capital spending and hiring.

Q.4. Are you concerned that keeping interest rates this low, 
for such an extended period of time, will have negative or 
dangerous consequences? Why, or why not?

A.4. The FOMC has established a very low level of short-term 
interest rates to foster its statutory objectives of maximum 
employment and stable prices. The FOMC has been very explicit 
in stating that the current very accommodative stance of 
monetary policy is conditional on the economic outlook, which 
includes low anticipated rates of resource utilization, subdued 
inflation trends, and stable inflation expectations. The 
explicit conditionality of the Federal Reserve's policy stance 
should help to guard against adverse outcomes such as a buildup 
in inflationary pressures or imbalances in financial markets. 
As the economy recovers, investors, seeing that the conditions 
supporting the current stance of policy have changed, will 
likely begin to anticipate the removal of policy accommodation; 
such anticipations of policy firming will, in turn, boost 
longer-term interest rates immediately, helping to damp any 
buildup in inflationary pressures. Of course, the Federal 
Reserve must be able to validate expectations of policy firming 
at the appropriate time. To do so, the Federal Reserve has a 
number of tools at its disposal. First, the Federal Reserve 
will put upward pressure on short-term interest rates by 
raising the rate it pays on the reserve balances held by 
depository institutions. Second, the Federal Reserve has 
developed reserve draining tools that can be employed to reduce 
the quantities of reserves outstanding and thereby tighten the 
relationship between the rate paid on reserve balances and 
short-term market rates. Finally, the Federal Reserve can sell 
assets at an appropriate time and pace to further tighten the 
stance of monetary policy. In short, the Federal Reserve has 
the tools necessary to effectively remove policy accommodation 
when such actions are warranted by the economic outlook. As 
always, the Federal Reserve is sensitive to the risks 
surrounding the outlook, and we are mindful of the possibility 
that very low interest rates could, if maintained for too long, 
lead to adverse economic outcomes. At the same time, there are 
risks that the premature removal of policy accommodation could 
undermine the economic recovery and contribute to unwelcome 
disinflationary pressures. The Federal Reserve will be 
monitoring economic and financial developments carefully to 
ensure that its policy actions appropriately balance these 
risks.
                                ------                                


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

Q.1. During initial Senate consideration of financial 
regulatory reform legislation, I was very concerned that State-
chartered community banks and small-and medium-sized bank 
holding companies would no longer be able to choose supervision 
from the Federal Reserve. I worried that community banks in 
Texas and across the country would lose access to the Federal 
Reserve, and, likewise, that the Fed would lose the important 
data that these important financial institutions provide on 
economic and banking conditions in communities in Texas and 
across the country.
    I was proud to sponsor Amendment 3759 during Senate 
consideration to ensure that State-chartered banks and small- 
and medium-sized bank holding companies could retain Federal 
Reserve supervision. I appreciate the support that you and many 
of the regional Federal Reserve presidents demonstrated to help 
my amendment pass with overwhelming support;
    I worked hard to ensure that community banks would not be 
unduly penalized as a result of the new regulations which will 
come from the Dodd-Frank Wall Street Reform and Consumer 
Protection Act. However, I continue to hear from many Texas 
community bankers sharing concerns about the possible effects 
of this legislation. The regulatory burden on community banks, 
particularly small banks in rural locations, was already 
significant prior to the enactment of legislation. Many in the 
Texas banking community fear that the rules soon to be written 
by the new Consumer Financial Protection Agency will be the 
tipping point for many community banks, making the regulatory 
burden too great to operate effectively. Texas community 
bankers are concerned that greater regulation will ultimately 
lead smaller community banks to succumb to larger banks, which 
would make the big bigger and wipe out the smaller banks.
    As a Member of the Committee on Banking, Housing, and Urban 
Affairs having oversight over the enactment of the Dodd-Frank 
Wall Street Reform and Consumer Protection Act, I respectfully 
ask the following:
    Which provisions of the Dodd-Frank Act require careful 
monitoring from the Committee because their respective 
implementation could be especially burdensome to community 
banks?

A.1. Although adjustments were made to moderate the impact of 
the Collins amendment, the effect of this provision (section 
171) on the ability of smaller banking organizations to access 
capital from the public markets warrants close monitoring. You 
are correct that the impact on community banks of various 
portions of the Dodd-Frank Act, such as the Title VII 
derivatives provisions and the Title X Consumer Financial 
Protection Bureau provisions, will depend in part on the 
regulatory implementation of those provisions. As I mentioned 
often during the debate, small community banks play a key role 
in our financial system. Close connections with community 
bankers enable the Federal Reserve to better understand the 
full range of financial concerns and risks facing the country. 
The community banking perspective is also critical as we assess 
the burden and effectiveness of financial regulation.

Q.2. What proposals do you have to help our Nation's community 
banks withstand the onslaught of new regulations so that they 
can remain competitive and avoid potential arbitrage in the 
future by larger banks?

A.2. Through implementation of provisions addressing the ``too-
big-to-fail'' problem, the Dodd-Frank Act should help to level 
the playing field between small and large banks. The Federal 
Reserve supported such provisions--including implementation of 
a resolution regime for large, interconnected firms and the 
imposition of more rigorous capital, liquidity, and supervisory 
requirements for large systemically important banking firms and 
nonbank financial institutions--in part because of the 
disparate treatment that resulted for banks of different sizes. 
Under the new law, the competitive position of community banks 
may be improved as implicit ``too-big-to-fail'' subsidies from 
which the largest banks previously benefited are removed 
through the higher supervisory costs and requirements placed on 
institutions that are or become large and systemically 
important.

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