[Senate Hearing 112-230]
[From the U.S. Government Publishing Office]
S. Hrg. 112-230
THE SEMIANNUAL MONETARY POLICY REPORT TO CONGRESS
=======================================================================
HEARING
before the
COMMITTEE ON
BANKING,HOUSING,AND URBAN AFFAIRS
UNITED STATES SENATE
ONE HUNDRED TWELFTH CONGRESS
FIRST SESSION
ON
THE FEDERAL RESERVE'S SEMIANNUAL MONETARY POLICY REPORT
TO CONGRESS
__________
JULY 14, 2011
__________
Printed for the use of the Committee on Banking, Housing, and Urban
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COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS
TIM JOHNSON, South Dakota, Chairman
JACK REED, Rhode Island RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York 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 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia MARK KIRK, Illinois
JEFF MERKLEY, Oregon JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina
Dwight Fettig, Staff Director
William D. Duhnke, Republican Staff Director
Charles Yi, Chief Counsel
Marc Jarsulic, Chief Economist
Laura Swanson, Policy Director
Andrew Olmem, Republican Chief Counsel
Mike Piwowar, Republican Senior Economist
Dana Wade, Professional Staff Member
Dawn Ratliff, Chief Clerk
Brett Hewitt, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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THURSDAY, JULY 14, 2011
Page
Opening statement of Chairman Johnson............................ 1
Opening statements, comments, or prepared statements of:
Senator Shelby............................................... 2
Senator Moran:
Prepared statement....................................... 41
WITNESS
Ben S. Bernanke, Chairman, Board of Governors of the Federal
Reserve System................................................. 3
Prepared statement........................................... 41
Response to written questions of:
Senator Shelby........................................... 105
Senator Reed............................................. 107
THE SEMIANNUAL MONETARY POLICY REPORT TO CONGRESS
----------
THURSDAY, JULY 14, 2011
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:03 a.m. in room SD-538, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. I call this hearing to order.
We are pleased to welcome Chairman Bernanke, who today will
deliver the Federal Reserve's semiannual Monetary Policy Report
to the Congress. His testimony comes at an important moment.
While our economy is recovering from the disaster created
by the financial crisis, the recovery is far from complete.
Employment is unacceptably low. The civilian unemployment rate
remains at 9.2 percent. The high levels of unemployment are
matched by output that is significantly lower than it ought to
be. CBO estimates of potential GDP show that the economy is 5.6
percent below what it could be producing. And, of course, the
housing market, which is an important source of wealth for many
families and our economy, has yet to recover from the collapse
of the house price bubble. Although prices are down
significantly from the 2006 peak level, inventories of vacant
houses remain high, and residential investment is below pre-
bubble levels.
In addition to these domestic economic problems, there are
concerns about how the European sovereign debt crisis will
develop and what affect it may have on our financial markets
and institutions.
Determining the best policy responses to such a complicated
set of economic circumstances is no easy matter, but one thing
is certain. We need to put the financial market safeguards of
the Dodd-Frank Act into place as soon as reasonably possible.
We must prevent a repetition of the events of 2007 and 2008.
Chairman Bernanke, I look forward to your insights on these
issues and to discussing the policy course the Federal Reserve
has taken.
To preserve time for questions, opening statements will be
limited to the Chair and Ranking Member. I now turn to Ranking
Member Shelby.
STATEMENT OF SENATOR RICHARD C. SHELBY
Senator Shelby. Thank you, Mr. Chairman. Welcome again,
Chairman Bernanke.
Last month the Federal Open Market Committee announced the
end of its second round of so-called quantitative easing,
commonly referred to as QE2. Chairman Bernanke had claimed that
because of QE2 we no longer have the deflation risk. The data
seems to support his claim here.
For example, the 12-month change in the Consumer Price
Index, which was 1.1 percent as recently as November, reached
3.6 percent in May. The rise in inflation, however, reveals
that the Fed's most challenging task still lies ahead, I
believe.
The Federal Reserve's balance sheet presently stands at
about $2.9 trillion while the Federal funds rate has been
effectively zero for more than 2 \1/2\ years. As a result, I
believe the stage is set for a resurgence of inflation if the
Fed is not real careful.
The task confronting the Fed is how to unwind its massive
balance sheet without sparking more inflation or damaging the
economy--a real task in itself. Unfortunately, the dismal
performance of our economy and our record Federal deficit will
make this exceedingly difficult in the years ahead.
Chairman Bernanke I believe must also contend with the
consequences of the Administration's economic policies. The
failure to adopt a pro-growth economic plan or to restrain
Federal spending has effectively boxed the Fed into a corner.
If the Fed is to curb inflation, it ultimately has to raise
interest rates, but the absence of economic growth will likely
make such a move more painful for the economy.
If the Fed does not raise interest rates, higher inflation
is almost assured. Federal borrowing costs could soar,
worsening the already severe Federal budget crisis that we
have.
The last thing our weak economy needs right now is an
inflation scare. The economic history of the 1970s should have
taught us that it is more painful to get inflation under
control than it is to keep inflation in check in the first
place.
History also demonstrates that the Fed's monetary policy
usually remains too loose for too long. Accordingly, our
markets are watching to see if Chairman Bernanke has not only a
credible plan but also the will to take the difficult actions
necessary to prevent inflation.
Today's hearing gives Chairman Bernanke an opportunity to
reassure our markets by explaining to the American people how
the Fed intends to navigate through this difficult period.
During Chairman Bernanke's last Humphrey-Hawkins testimony,
I was pleased that he explicitly stated the Fed's price
stability target is about 2 percent. Today I would like to know
more about how the Fed plans to achieve this target. For
example, what is the acceptable range around a 2-percent
inflation target? Does the Fed think that the recent inflation
data, which shows inflation above 3 percent, violates this
target? If inflation is above target, how does the Fed plan to
reduce it?
In addition, I would like to know how the ongoing turmoil
in the European Union could impact monetary policy here. In
particular, will the euro crisis further constrain the Fed's
ability to maintain price stability? More transparency we all
believe is needed with regard to how the Fed plans to unwind
its record balance sheet. And although the Federal Open Market
Committee has terminated QE2, it has said that it will maintain
the policy of reinvesting principal payments from its existing
securities holdings.
Chairman Bernanke's testimony here further indicates that
the Federal Open Market Committee may consider another round of
quantitative easing if the weak economy continues, and as a
result, the Fed's balance sheet could easily balloon way beyond
$3 trillion.
It appears that the Fed may be going in the wrong
direction. Recent Federal Open Market Committee minutes,
however, indicate that the Fed is developing plans for
addressing its balance sheet. I hope that Chairman Bernanke can
shed here this morning more light on the options that the Fed
is considering and when the Fed will begin its difficult task.
Finally, I would like to commend Chairman Bernanke on his
recent decision to hold press conferences after Federal Open
Market Committee meetings. This is an important step that
recognizes that the Fed can no longer make policy behind closed
doors. This is a positive development because the Fed's
policies will be more effective if they are understood and
supported by the public.
This step also recognizes that the Fed's secretive history
is an antiquated practice that simply is incompatible with a
free society. The Fed is a public institution, and the public
has the right to expect both transparency and accountability.
The Fed still has far to go in opening up, but I hope Chairman
Bernanke will continue his efforts to modernize the Fed's
transparency. I believe the American people deserve nothing
less.
Thank you, Mr. Chairman.
Chairman Johnson. Chairman Bernanke, before you begin your
testimony, I wanted to let you know that I may have to excuse
myself during today's hearing. In another role as Chairman of
the Military Construction VA's Appropriations Subcommittee, I
may need to be on the floor this morning as we begin debate on
that bill. Senator Reed will be taking over the gavel.
Senator Reed, thank you.
Chairman Bernanke, please begin.
STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF GOVERNORS OF
THE FEDERAL RESERVE SYSTEM
Mr. Bernanke. Thank you, Mr. Chairman, Ranking Member
Shelby, and other Members of the Committee. I am pleased to
present the Federal Reserve's semiannual Monetary Policy Report
to the Congress. I will start with a discussion of current
economic conditions and the outlook and then turn to monetary
policy.
The U.S. economy has continued to recover, but the pace of
the expansion so far this year has been modest. After
increasing at an annual rate of 2 \3/4\ percent in the second
half of 2010, real GDP rose at about a 2-percent rate in the
first quarter of this year, and incoming data suggest that the
pace of recovery remained soft in the spring. At the same time,
the unemployment rate, which had appeared to be on a downward
trajectory at the turn of the year, has moved back above 9
percent.
In part, the recent weaker-than-expected economic
performance appears to have been the result of several factors
that are likely to be temporary. Notably, the run-up in prices
of energy, especially gasoline, and food has reduced consumer
purchasing power. In addition, the supply chain disruptions
that occurred following the earthquake in Japan caused U.S.
motor vehicle producers to sharply curtail assemblies and
limited the availability of some models. Looking forward,
however, the apparent stabilization in the prices of oil and
other commodities should ease the pressure on household
budgets, and vehicle manufacturers report that they are making
significant progress in overcoming the parts shortages and
expect to increase production substantially this summer.
In light of these developments, the most recent projections
by members of the Federal Reserve Board and presidents of the
Federal Reserve Banks, prepared in conjunction with the FOMC
meeting in late June, reflected their assessment that the pace
of the economic recovery will pick up in coming quarters.
Specifically, participants' projections for the increase in
real GDP have a central tendency of 2.7 to 2.9 percent in 2011,
inclusive of the weak first half, and 3.3 to 3.7 percent in
2012--projections that, if realized, would constitute a notably
better performance than we have seen so far this year.
FOMC participants continued to see the economic recovery
strengthening over the medium term, with the central tendency
of their projections for the increase in real GDP picking up to
3.5 to 4.2 percent in 2013. At the same time, the central
tendencies of the projections of real GDP growth in 2011 and
2012 were marked down nearly one-half percentage point compared
with those reported in April, suggesting that FOMC participants
saw at least some part of the first-half slowdown as persisting
for a while. Among the headwinds facing the economy are the
slow growth in consumer spending, even after accounting for the
effects of higher food and energy prices; the continuing
depressed condition of the housing sector; still-limited access
to credit for some households and small businesses; and fiscal
tightening at all levels of Government. Consistent with
projected growth in real output modestly above its trend rate,
FOMC participants expected that, over time, the jobless rate
will decline--albeit only slowly--toward its longer-term normal
level. The central tendencies of participants' forecasts for
the unemployment rate were 8.6 to 8.9 percent for the fourth
quarter of this year, 7.8 to 8.2 percent at the end of 2012,
and 7 to 7.5 percent at the end of 2013.
The most recent data attest to the continuing weakness of
the labor market: The unemployment rate increased to 9.2
percent in June, and gains in non-farm payroll employment were
below expectations for a second month. To date, of the more
than 8.5 million jobs lost in the recession, 1.75 million have
been regained. Of those employed, about 6 percent--8.6 million
workers--report that they would like to be working full time
but can only obtain part-time work. Importantly, nearly half of
those currently unemployed have been out of work for more than
6 months, by far the highest ratio in the post-World War II
period. Long-term unemployment imposes severe economic
hardships on the unemployed and their families, and by leading
to an erosion of skills of those without work, it both impairs
their lifetime employment prospects and reduces the productive
potential of our economy as a whole.
Much of the slowdown in aggregate demand this year has been
centered in the household sector, and the ability and
willingness of consumers to spend will be an important
determinant of the pace of the recovery in coming quarters.
Real disposable personal income over the first 5 months of 2011
was boosted by the reduction in payroll taxes, but those gains
were largely offset by higher prices for gasoline and other
commodities. Households report that they have little confidence
in the durability of the recovery and about their own income
prospects. Moreover, the ongoing weakness in home values is
holding down household wealth and weighing on consumer
sentiment. On the positive side, household debt burdens are
declining, delinquency rates on credit cards and auto loans are
down significantly, and the number of homeowners missing a
mortgage payment for the first time is decreasing. The
anticipated pickups in economic activity and job creation,
together with the expected easing of price pressures, should
bolster real household income, confidence, and spending in the
medium run.
Residential construction activity remains at an extremely
low level. The demand for homes has been depressed by many of
the same factors that have held down consumer spending more
generally, including the slowness of the recovery in jobs and
income as well as poor consumer sentiment. Mortgage interest
rates are near record lows, but access to mortgage credit
continues to be constrained. Also, many potential homebuyers
remain concerned about buying into a falling market, as weak
demand for homes, the substantial backlog of vacant properties
for sale, and the high proportion of distressed sales are
keeping downward pressure on house prices.
Two bright spots in the recovery have been exports and
business investment in equipment and software. Demand for U.S.-
made capital goods from both domestic and foreign firms has
supported manufacturing production throughout the recovery thus
far. Both equipment and software outlays and exports increased
solidly in the first quarter, and the data on new orders
received by U.S. producers suggest that the trend continued in
recent months. Corporate profits have been strong, and larger
nonfinancial corporations with access to capital markets have
been able to refinance existing debt and lock in funding at
lower yields. Borrowing conditions for businesses generally
have continued to ease, although, as mentioned, the
availability of credit appears to remain relatively limited for
some small firms.
Inflation has picked up so far this year. The price index
for personal consumption expenditures rose at an annual rate of
more than 4 percent over the first 5 months of 2011 and 2.5
percent on a 12-month basis. Much of the acceleration was the
result of higher prices for oil and other commodities and for
imported goods. In addition, prices of motor vehicles increased
sharply when supplies of new models were curtailed by parts
shortages associated with the earthquake in Japan. Most of the
recent rise in inflation appears likely to be transitory, and
FOMC participants expected inflation to subside in coming
quarters to rates at or below the level of 2 percent or a bit
less that participants view as consistent with our dual mandate
of maximum employment and price stability. The central tendency
of participants' forecasts for the rate of increase in the PCE
price index was 2.3 to 2.5 percent for 2011 as a whole, which
implies a significant slowing of inflation in the second half
of the year. In 2012 and 2013, the central tendency of the
inflation forecasts was 1.5 to 2.0 percent. Reasons to expect
inflation to moderate include the apparent stabilization in the
prices of oil and other commodities, which is already showing
through to retail gasoline and food prices; the still-
substantial slack in U.S. labor and product markets, which has
made it difficult for workers to obtain wage gains and for
firms to pass through their higher costs; and the stability of
longer-term inflation expectations, as measured by surveys of
households, the forecasts of professional private sector
economists, and financial market indicators.
Turning to monetary policy, FOMC members' judgments that
the pace of the economic recovery over coming quarters will
likely remain moderate, that the unemployment rate will
consequently decline only gradually, and that inflation will
subside are the basis for the Committee's decision to maintain
a highly accommodative monetary policy. As you know, that
policy currently consists of two parts.
First, the target range for the Federal funds rate remains
at 0 to one-fourth percent and, as indicated in the statement
released after the June meeting, the Committee expects that
economic conditions are likely to warrant exceptionally low
levels of the Federal funds rate for an extended period.
The second component of monetary policy has been to
increase the Federal Reserve's holdings of longer-term
securities, an approach undertaken because the target for the
Federal funds rate could not be lowered meaningfully further.
The Federal Reserve's acquisition of longer-term Treasury
securities boosted the prices of such securities and caused
longer-term Treasury yields to be lower than they would have
been otherwise. In addition, by removing substantial quantities
of longer-term Treasury securities from the market, the Fed's
purchases induced private investors to acquire other assets
that serve as substitutes for Treasury securities in the
financial marketplace, such as corporate bonds and mortgage-
backed securities. By this means, the Fed's asset purchase
program--like more conventional monetary policy--has served to
reduce the yields and increase the prices of those other assets
as well. The net result of these actions is lower borrowing
costs and easier financial conditions throughout the economy.
We know from many decades of experience with monetary
policy that, when the economy is operating below its potential,
easier financial conditions tend to promote more rapid economic
growth. Estimates based on a number of recent studies as well
as Federal Reserve analyses suggest that, all else being equal,
the second round of asset purchases probably lowered longer-
term interest rates approximately 10 to 30 basis points.
Our analysis further indicates that a reduction in longer-
term interest rates of this magnitude would be roughly
equivalent in terms of its effects on the economy to a 40- to
120-basis-point reduction in the Federal funds rate.
In June, we completed the planned purchases of $600 billion
in longer-term Treasury securities that the Committee initiated
in November, while continuing to reinvest the proceeds of
maturing or redeemed longer-term securities in Treasuries.
Although we are no longer expanding our securities holdings,
the evidence suggests that the degree of accommodation
delivered by the Federal Reserve's securities purchase program
is determined primarily by the quantity and mix of securities
that the Federal Reserve holds rather than by the current pace
of new purchases. Thus, even with the end of net new purchases,
maintaining our holdings of these securities should continue to
put downward pressure on market interest rates and foster more
accommodative financial conditions than would otherwise be the
case. It is worth emphasizing that our program involved
purchases of securities, not Government spending, and as I will
discuss later, when the macroeconomic circumstances call for
it, we will unwind those purchases. In the meantime, interest
on those securities is being remitted to the U.S. Treasury.
When we began this program, we certainly did not expect it
to be a panacea for the country's economic problems. However,
as the expansion weakened last summer, developments with
respect to both components of our dual mandate implied that
additional monetary policy accommodation was needed. In that
context, we believed that the program would both help reduce
the risk of deflation that had emerged and provide a needed
boost to faltering economic activity and job creation. The
experience to date with the round of securities purchases that
just ended suggests that the program had the intended effects
of reducing the risk of deflation and shoring up economic
activity. In the months following the August announcement of
our policy of reinvesting maturing and redeemed securities and
our signal that we were considering more purchases, inflation
compensation as measured in the market for inflation-indexed
securities rose from low to more normal levels, suggesting that
the perceived risks of deflation had receded markedly. This was
a significant achievement, as we know from the Japanese
experience that protracted deflation can be quite costly in
terms of weaker economic growth.
With respect to employment, our expectations were
relatively modest; estimates made in the autumn suggested that
the additional purchases could boost employment by about
700,000 jobs over 2 years, or about 30,000 extra jobs per
month. Even including the disappointing readings for May and
June, which reflected in part the temporary factors I discussed
earlier, private payroll gains have averaged 160,000 per month
in the first half of 2011, compared with average increases of
only about 80,000 private jobs per month from May to August
2010. Not all of the step-up in hiring was necessarily the
result of the asset purchase program, but the comparison is
consistent with our expectations for employment gains. Of
course, we will be monitoring developments in the labor market
closely.
Once the temporary shocks that have been holding down
economic activity pass, we expect to again see the effects of
policy accommodation reflected in stronger economic activity
and job creation. However, given the range of uncertainties
about the strength of the recovery and prospects for inflation
over the medium term, the Federal Reserve remains prepared to
respond should economic developments indicate that an
adjustment in the stance of monetary policy would be
appropriate.
On the one hand, the possibility remains that the recent
economic weakness may prove more persistent than expected and
that deflationary risks might re-emerge, implying a need for
additional policy support. Even with the Federal funds rate
close to zero, we have a number of ways in which we could act
to ease financial conditions further. One option would be to
provide more explicit guidance about the period over which the
Federal funds rate and the balance sheet would remain at their
current levels. Another approach would be to initiate more
securities purchases or to increase the average maturity of our
holdings. The Federal Reserve could also reduce the 25-basis-
point rate of interest it pays to banks on their reserves,
thereby putting downward pressure on short-term rates more
generally. Of course, our experience with these policies
remains relatively limited, and employing them would entail
potential risks and costs. However, prudent planning requires
that we evaluate the efficacy of these and other potential
alternatives for deploying additional stimulus if conditions
warrant.
On the other hand, the economy could evolve in a way that
would warrant a move toward less accommodative policy.
Accordingly, the Committee has been giving careful
consideration to the elements of its exit strategy, and as
reported in the minutes of the June FOMC meeting, it has
reached a broad consensus about the sequence of steps that it
expects to follow when the normalization of policy becomes
appropriate. In brief, when economic conditions warrant, the
Committee would begin the normalization process by ceasing the
reinvestment of principal payments on its securities, thereby
allowing the Federal Reserve's balance sheet to begin
shrinking. At the same time or sometime thereafter, the
Committee would modify the forward guidance in its statement.
Subsequent steps would include the initiation of temporary
reserve-draining operations and, when conditions warrant,
increases in the Federal funds rate target. From that point on,
changing the level or range of the Federal funds rate target
would be our primary means of adjusting the stance of monetary
policy in response to economic developments.
Sometime after the first increase in the Federal funds rate
target, the Committee expects to initiate sales of agency
securities from its portfolio, with the timing and pace of
sales clearly communicated to the public in advance. Once sales
begin, the pace of sales is anticipated to be relatively
gradual and steady, but it could be adjusted up or down in
response to material changes in the economic outlook or
financial conditions. Over time, the securities portfolio and
the associated quantity of bank reserves are expected to be
reduced to the minimum levels consistent with the efficient
implementation of monetary policy. Of course, conditions can
change, and in choosing the time to begin policy normalization
as well as the pace of that process, should that be the next
direction for policy, we would carefully consider both parts of
our dual mandate.
Thank you, and I would be pleased to take your questions.
Chairman Johnson. Thank you for your testimony. We will now
begin the questioning of our witness. Will the Clerk please put
5 minutes on the clock for each Member for their questions.
The Fed, to its great credit, has pursued policies to
stimulate the economy. However, although the Fed continues to
hold short-term interest rates near zero, it has ended efforts
to reduce longer-term rates through quantitative easing. Given
the high rate of unemployment and relatively slow growth in
output, why not start a new round of easing, a QE3?
Mr. Bernanke. Well, Mr. Chairman, first, as you point out,
our policies are already very highly accommodative. We have
almost zero interest rates. And the stock of assets that we
have acquired, which Mr. Shelby talked about, continue to put
downward pressure on interest rates in the markets, even if we
are not buying new assets going forward.
I think the important point to make is that the situation
today is somewhat different than it was in August of 2010, when
we began to initiate discussion of further purchases of
securities. At that time, inflation was dropping. Inflation
expectations were dropping. It looked like deflation was
becoming a potential risk to the economy, and a serious risk.
At the same time, over the summer, the recovery looked like it
was stalling. We were down to 80,000 jobs a month, private
sector jobs a month. Growth was not sufficient to prevent what
looked like a potentially significant increase in the
unemployment rate, and so we felt that with both unemployment
and inflation being missed in the same direction, so to speak,
that monetary policy accommodation was surely needed and so we
undertook that step.
Today, the situation is more complex. Inflation is higher.
Inflation expectations are close to our target. We are
uncertain about the near-term developments in the economy. We
would like to see if the economy does pick up as we are
projecting. And so we are not prepared at this point to take
further action.
Chairman Johnson. In your testimony, you note that fiscal
tightening at all levels of Government is one of the headwinds
facing the economic recovery. Can you explain whether this
means that additional short-term fiscal expansion could help us
return to full employment and increase overall confidence in
the economy.
Mr. Bernanke. Mr. Chairman, I think our fiscal planning and
policy needs to be integrated in the sense that we have to be
looking at both the short run and the long run at the same
time. The Congress and the Administration are currently looking
to make major changes in our spending, deficit projections over
the next decade or so. I think that is extremely important,
that we bring down our deficit so we will have a sustainable
fiscal policy going forward, and I want to emphasize that that
is very important.
At the same time, that process is a long-term process. It
is something that needs to take place over a number of years.
And I only ask or suggest that as Congress looks at the timing
and composition of its changes to the budget that it does take
into account that in the very near term that the recovery is
still rather fragile and that sharp and excessive cuts in the
very short term would be potentially damaging to that recovery.
It is up to Congress what further actions to take. I guess
I could suggest that there is intermediate steps between fiscal
stimulus and cuts, and that would be some focused programs
addressing some of the areas in the economy which are
particularly stressed, like unemployment or housing.
Chairman Johnson. As you acknowledge in your testimony, the
U.S. housing market is stubbornly depressed. Residential
investment is more than a third below its 1997 level. The
inventory of homes that are vacant and for sale remains
elevated. Do you see policy solutions that would help resolve
the problems in the housing market?
Mr. Bernanke. Well, Mr. Chairman, you are absolutely right
that the weakness in the housing market is one of the major
sources of the slow recovery. Normally, in an expansion, you
would see the housing market strengthening and adding jobs and
creating new opportunities. We are not seeing that, in part
because, as you mentioned, the big overhang of distress sales,
open, vacant homes, foreclosed homes which are weighing on
prices and creating a vicious circle, where people do not want
to buy because prices are falling, and prices are falling
because people do not want to buy.
There are a number of things that we are doing. The Fed is
keeping mortgage rates low. There is work to try to modify
mortgages. I think it is worth looking at that area, though.
One area where clearly more work needs to be done is in housing
finance. You know, we have not yet begun to really clarify for
the market and the public how housing finance will be conducted
in the future.
Another area where I just suggest that you might think
about is the overhang of distressed houses. For example,
Fannie, Freddie, and the banks own about half-a-million homes
right now which are basically sitting there on the market and
which are pressing down prices and reducing appraisals and
making the housing market just much weaker than it otherwise
would be. So that is another area to look at. I mean, there are
various things that one could do to approach that, but I agree
with you that the housing market is really, in some sense, the
epicenter of the problem we have at the moment.
Chairman Johnson. As yet, there has been no agreement on
raising the Federal debt limit. What would be the effects on
financial markets and the real economy if the Treasury were
forced to default on these obligations?
Mr. Bernanke. Well, Mr. Chairman, as I have said on a
number of occasions, I think it would be a calamitous outcome.
It would create a very severe financial shock that would have
effects not only to the U.S. economy, but on the global
economy. Treasury securities are critical to the entire
financial system. They are used in many different ways as
collateral or as margin. Default on those securities would
throw the financial system into chaos, and what would certainly
be the case is that we would destroy the trust and confidence
that global investors have in U.S. Treasury securities as being
the safest and most liquid assets in the world. We are already
seeing threats of downgrades from rating agencies.
This is a tremendous asset of the United States, the
quality and reputation of our Treasury securities, and we
benefit from it with low interest rates. So I would urge
Congress to take every step possible to avoid defaulting on the
debt or creating even any significant probability of defaulting
on the debt.
Chairman Johnson. Senator Shelby.
Senator Shelby. Thank you.
Mr. Chairman, tell us here today, and, of course, you are
speaking to the American people, why our economy is not moving,
our jobs are not growing, unemployment is going in the wrong
direction, what, 9.2 official unemployment right now. If you
bring in, according to the Labor Department, if you bring in
people who have quit looking for a job, it is about 16 percent.
That is very, very high. I think it does not bode well for the
future for all of us. But why, why is all of this? Is it just
the housing bubble, which is severe? Is it the housing bubble
and reckless lending that put a lot of our banks in jeopardy?
Tell us what it all is and how do we get out of it? Is it
reckless spending? All of this.
Mr. Bernanke. Well, Senator, you have almost answered your
question.
Senator Shelby. Mm-hmm. Not as well as you could, probably.
Mr. Bernanke. Well, first, let me say that, as I mentioned
in my testimony, we do think that the weakness of the first
half of this year is, in part, due to temporary factors, and I
talked about the disaster in Japan and the developments in the
Middle East and so on, and we do think we will see somewhat
better growth, although forecasting is very difficult, going
forward.
But that being said, it has been a very slow recovery and
there are a number of reasons for that. One is the aftermath of
the housing bubble. With so many houses empty and prices having
fallen so much, that has created almost new construction in
housing. It means that people have lost wealth because they no
longer have any equity in their home. So that has been a major
factor.
Second is that we know from a lot of research that
recoveries after financial crises can be slow because it takes
time for the credit system to become operative again. And while
I think there has been a lot of improvement in the banking
system, there are still some areas, like consumer and small
business lending, which are constrained to some extent.
The consumer has been very cautious, trying to build back
up their wealth, concerned about the durability of the
recovery, worried about their own financial prospects. So even
though the high price of gasoline and food has taken away some
purchasing power, as I mentioned, confidence is pretty low and
consumers are not showing the confidence in terms of spending.
And then I did mention that there is, in the near term,
withdrawal of fiscal stimulus, tightening. For example, the job
numbers last Friday, the private numbers were certainly better
than the headline numbers because part of this report was the
loss of 40,000 State and local jobs as those governments are
being forced to contract. Now, of course, over time it is
perfectly possible to want to change the composition of public
and private employment. That is perfectly understandable. But
in the short run, as jobs are lost and they are not replaced
elsewhere, it creates pressure on the economy.
Senator Shelby. Are you basically telling us we are not
going to have a robust recovery, not in the next 6 months, 8
months, 10 months, are we?
Mr. Bernanke. We are expecting improvement, but we are not
expecting----
Senator Shelby. Nothing----
Mr. Bernanke.----something like would normally follow a
deep recession in previous episodes.
Senator Shelby. Let us talk about the European crisis for a
minute. We are all familiar with this to some extent, Greece,
Portugal, Ireland, perhaps Italy and others. It seems to me
that they are sitting on a financial-related time bomb over
there. Do you believe that the European Union, Monetary Union,
will stay together? Can it stay together with some smaller
countries' fragile economies that will basically never pay
their debt back, cannot pay it back, or what will happen?
Mr. Bernanke. Well----
Senator Shelby. And how will it impact us, because we will
be----
Mr. Bernanke.----let me just say that the European
leadership places a great value on maintaining the Euro area
and in maintaining the European political integration which has
taken place in the post-war period, and I know they are making
extraordinary efforts to address these problems.
The problems are not entirely economic because the three
countries that you mentioned are really a very small part of
the European continent and the European economy. So the
questions are at least as much political, and they involve how
are you going to address these problems in these countries.
One approach is to try to do it completely through
austerity, to have the countries just cut and cut and see if
they can make it with a little bit of temporary assistance.
Another strategy would be to get more direct assistance from
other countries, but that is a very unpopular strategy in some
of the countries that would be expected to pay----
Senator Shelby. But that is not a solution to their
problem, though----
Mr. Bernanke. Well, if the better-off countries were to
basically help solve the problems of the small countries, it
would solve their immediate issue and then there would need to
be austerity, fiscal reforms, structural reforms, and so on to
make sure the countries stay on a healthier path in the future.
So there are different ways to approach it, and again, I think
it is really a political issue as much as an economic issue.
It is causing a good bit of anxiety in markets, and that
has been affecting our economy both last summer and now
recently, as well. We are spending a lot of time evaluating the
exposures of U.S. financial institutions to these countries,
including money market mutual funds and so on. The direct
exposures to the three countries you mentioned are quite small
and manageable. So we would not expect those direct impacts to
be the critical channel if there were problems; a default, for
example.
But I think that, nevertheless, the U.S. economy is at risk
from those developments because were there to be a significant
deterioration in conditions in Europe, we would see a general
increase in risk aversion, declining asset prices, a lot of
volatility in markets, and we would suffer from that more
general financial situation than we would from the direct
exposures to those sovereign countries.
Senator Shelby. Thank you, Mr. Chairman.
Chairman Johnson. Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman.
Mr. Chairman, following up on Senator Johnson's question,
which was about a default on our outstanding obligations of the
Federal Government, some have suggested that if we cannot
resolve the debt ceiling limit, we simply prioritize payments.
We presumably pay on some Treasuries as long as we can, pay
some principal, some interest. That, of course, requires us to
not pay on things like military pay and Social Security.
But just in the context of the financial sector, would that
fix the problem, simply not having the debt limit extended and
trying to pay as long as we can on our securities?
Mr. Bernanke. Well, Senator Reed, first of all, it is the
Treasury's area to determine how they are going to manage this.
They have been very clear that they do not think it is either
appropriate or feasible to prioritize. And as the fiscal agent,
the Federal Reserve simply does what they tell us to do, and I
think there are some operational issues that arise if you were
to try to do it. But again, the Treasury is the determinant of
this and they are pretty clear that they do not think that is a
workable solution.
That being said, whether the default is on securities or it
is on payments we owe to Medicare recipients, it is going to
constitute a default of some type on obligations incurred by
the U.S. Government. It will certainly have an impact on both
the economy, but also on confidence. You know, what inference
should investors take from the fact that the United States is
not paying its bills and that it cannot resolve this issue?
So I think that there is not really any solution other than
to find a way to solve these problems, to address the fiscal
issues, and to----
Senator Reed. Pass the debt limit.
Mr. Bernanke.----raise the debt limit at the appropriate
time.
Senator Reed. Let me just explore a little bit. Moody's
today and Standard and Poor's have suggested that they are
putting us on a watch, downgrading, and what clearly is behind
them is that if we do not pass the debt limit ceiling raise,
then they will downgrade us, not only U.S. Treasuries, but
Moody's has indicated Fannie Mae paper, Freddie Mac paper,
Federal Credit Bureau paper. We have also placed for possible
downgrade securities either guaranteed by, backed by,
collateral securities issued by, or otherwise directly linked
to the U.S. Government. So, essentially, they are going to
downgrade things we do not even know yet--maybe you know.
What does this do in terms of interest rates across the
board, likely raise them, even in a, quote, ``technical''
default?
Mr. Bernanke. Well, the combination of downgrades and loss
of investor confidence could potentially raise interest rates
quite significantly. And the ironic aspect of that is what we
are all interested in doing is reducing the deficit. If you
raise interest rates, that means your interest costs go up
substantially and you are actually making--you are regressing
rather than progressing in terms of----
Senator Reed. So a failure to raise the debt ceiling would
be probably the most significant and immediate increase in the
deficit that we are likely to see, the one act that would
dramatically increase the deficit?
Mr. Bernanke. It would be a self-inflicted wound, I would
say.
Senator Reed. Let me ask about something else, too, and
that is--because you have talked about the fiscal crisis, but
also a jobs crisis. What is your presumption into this scenario
about jobs? Are we likely to see people eagerly going out and
hiring under this situation of technical or real default?
Mr. Bernanke. Well, we have a recent example. In 2008, when
the financial system froze up and we saw an immediate, very
sharp contraction of the global economy. Even if things did not
get that bad, and one of the key issues here is it is very hard
to predict exactly what is going to happen, but if interest
rates rise, that is clearly going to reduce investment.
Uncertainty will arise. That will reduce the willingness of
firms to hire and invest. So if the Government is reducing its
payments by 40 percent, that is going to have an impact, as
well.
Senator Reed. Right.
Mr. Bernanke. So I can only conclude that this would be
very bad for jobs.
Senator Reed. Let me ask you another area which we
discovered much to our chagrin was a huge and explosive
problem. That is the situation of derivatives. I would presume
that there area a lot of credit default swaps written on many
of these securities, et cetera, and that if they are
downgraded, that could be a condition of default. That could
require additional collateral. Do you have any idea on the
institutions that you regulate the potential exposure they
would have as credit ratings fall or as there is a default in
the market? Is it in the trillions?
Mr. Bernanke. Well, there are many knock-on effects from a
default, ranging throughout the entire system. But CDS directly
on Treasuries as opposed to on other securities are actually
not that big, and it would take an action of the ISDA to invoke
the credit event. So that could be a problem for some
institutions, but it would not be the biggest problem among all
the things that we have been discussing.
Senator Reed. But your point, which I want to reiterate, is
that this could be a self-inflicted wound doing more damage to
the deficit than has been done to date.
Mr. Bernanke. It is really not an option that we want--we
should be considering.
Senator Reed. Thank you.
Chairman Johnson. Senator Toomey.
Senator Toomey. Thank you, Mr. Chairman, and I am going to
follow up on this for just a moment, but then I want to move on
to some other issues, and that is to make the observation that
the market proceeds, and, in fact, the consequences are starkly
different between, on the one hand, the U.S. Government failing
to make an interest payment on a bond, or on the other hand,
furloughing some Government workers or delaying a reimbursement
to a vendor or failing to cut the grass at the monument. These
are very, very different events.
The month of August has scheduled about $30 billion of
interest payments. The Treasury is sitting on a $94 billion
portfolio of mortgage-backed securities and we expect a minimum
of $125 billion in tax revenue. Now, I do not know of anybody
that suggests that we can or should go indefinitely without
raising the debt ceiling, and I have argued that we certainly
would be much better off reaching an agreement and raising the
debt ceiling prior to August 2. But there is a big, big
difference between a payment default on our debt and the other
kinds of payment disruptions.
I think this Administration would be wise to send an
unambiguous message to the market that under no circumstances
would they tolerate a default on our debt which is entirely
under their control to prevent. But I acknowledge that that is
the realm of the Treasury and that is not your responsibility.
What I would like to address is what is under your realm,
and I have said, Mr. Chairman, and I fully acknowledge that the
things that you have done under very difficult circumstances
have only had the best motivation, but I am concerned about the
expansion in power of the central bank that we have, the
unusual steps that we have taken, the enormous discretion that
the Fed now has and exercises. My concern is that this distorts
markets, intentionally, actually. It also introduces enormous
uncertainty as to how the Fed will behave. The Fed becomes the
biggest player in driving the bond market, the equity markets,
and that this is a dangerous place that we have come to, and I
hope that we revert as soon as possible to the more normal role
that the Fed has played.
One of the unintended, I suspect, if not unforseen
consequences of this unusual policy, it seems to me, if we take
the very, very low interest rates, the zero, or roughly zero
percent Fed funds rate, the negative real interest rates the
Fed has maintained for an extended period now, it seems to me
that this contributes to enabling Congress to run excessive
deficits. You know, our debt is cheap to finance, especially
when compounded by the fact that the Treasury has chosen to
shorten up the maturity--I think unwisely. The net effect is we
are not yet paying the price, the real market price that we
will certainly eventually have to pay for these massive
deficits and this huge debt. I do not think for a minute that
that is your intention, to facilitate this fiscal
irresponsibility, but I think it is the unintended consequence
of these extremely low interest rates, as just one example.
But to your testimony, you have raised the possibility now
that if economic circumstances warranted, you would consider--
you have opened the door to an additional round of securities
purchases, so what will no doubt be dubbed QE3. And I guess my
concern is that what is wrong with this economy is not
fundamentally monetary policy. It is other things.
And so I would just ask you to comment on what you see that
is wrong with our economy that QE3 would fix. What is the
theory that another round of security purchases will somehow
generate the economic growth that we lack?
Mr. Bernanke. Well, first, to go back to the facilitation
issue, our goal is to try to meet our mandate of maximum
employment and price stability, which is why we run monetary
policy as we do. I do not think that our policy would prevent a
loss of confidence if creditors lost confidence in the
Treasury, which would drive up interest rates. It has not
happened yet, and I do not think it is because of us. I think
it is because people still think that they have confidence in
our Government's ability to make its payments.
These asset purchases, in terms of their effects on the
economy, they work more or less in the same way that ordinary
monetary policy works, by easing financial conditions, lowering
interest rates, and providing stimulus through that mechanism.
Now, you may be entirely correct, A, that it might not be
needed, and B, that it might not be particularly effective
given the configuration of problems that we have, if credit is
not being extended, or if the problems really arise from other
sectors that are not responsive to interest rates. So those are
certainly things we will take into account, Senator. We are not
proposing anything today.
The main message I want to leave is that this is a serious
situation. It involves a significant loss of human and economic
potential. The Federal Reserve has a mandate and we want to
meet that mandate, and to do that, we just want to make sure
that we have the options when they become necessary. But at
this point, we are not proposing to undertake that option.
Senator Toomey. Thank you, Mr. Chairman.
Chairman Johnson. Senator Akaka.
Senator Akaka. Thank you very much, Mr. Chairman.
Good morning, Chairman Bernanke.
Mr. Bernanke. Good morning, Senator.
Senator Akaka. I appreciate your joining us today again.
Before I begin, I want to thank you very much for your strong
leadership. You continue to do an excellent job under very
difficult circumstances.
Chairman Bernanke, we all understand the importance of
preventing a Government default. Many Americans, however, seem
not to share this urgency. A Gallup poll in May found that only
19 percent of Americans would want their Member of Congress to
vote for a debt ceiling increase, and 34 percent did not even
know enough about the issue to answer the question. Another
poll in July by Pew and Washington Post showed that Americans
are more concerned about controlling spending than they are
about a Government default.
Chairman Bernanke, will you please explain specifically how
a Government default would affect the everyday lives of
working-class Americans.
Mr. Bernanke. Yes, Senator, I would be glad to. First, an
analogy I made yesterday, some people make the analogy that
this is all about sitting down at the kitchen table, making
sure that your income and your spending are equal. That is true
for the long run, but the debt ceiling is really about paying
for bills that we have already incurred. So it is more like
saying we are going to solve our problems by defaulting on our
credit card, which is not something that most people would
consider would be the right way to behave.
But putting that aside, not increasing the debt ceiling and
certainly allowing default on the debt would have very real
consequences for average Americans. First, interest rates would
jump. Treasury rates are the benchmark interest rates, so
mortgage rates and all other interest rates that consumers pay
would rise. Of course, that would also increase the Federal
deficit because we have to pay the interest on the debt as part
of our spending.
If the Treasury cut back as it would be required to do
because it could not borrow, it would mean that there would be
a significant reduction in both the payments, the benefits,
payments for services paid to the Armed Forces and so on, so
people would see that in terms of their Medicare check or
whatever other benefits they are getting.
And then without much delay, I think this would also slow
the economy, and so the job situation would get worse. So in
almost every area where people have pocketbook concerns--jobs,
interest rates, credit, availability of Government payments,
benefits, all those things would be affected in relatively
short order.
Senator Akaka. Well, thank you for briefly explaining all
of that.
Chairman Bernanke, even though home prices, and it has been
mentioned, have only slightly declined, high-cost housing areas
like Hawaii are still feeling the full effects of a weak
housing market. Mortgage credit is still limited. Concern for
the future is that bank retained mortgages are performing worse
than those sold to or backed by the Government and yet the loan
limits are scheduled to step down later this year.
Do you think it is a good idea to allow the loan limits to
decrease? How might loan limits affect the housing market and
homeownership opportunities?
Mr. Bernanke. Well, there is a tradeoff, as always,
Senator. The increase in the loan limits was made on an
emergency basis, obviously, to try to address the housing
crisis. The GSEs are making the determination that it is time
to begin to wean a little bit the mortgage market from those
higher conforming limits.
I think the question in terms of the effect on the housing
market is to what extent are non-conforming jumbo mortgages
available and how are they priced in Hawaii, and I do not know
specific facts for Hawaii. But, nationally, there has been some
improvement in the willingness of banks to make jumbo loans,
and the differential, which at one point was more than 100
basis points, I think is much closer to 25 to 35 basis points
at this point.
So that will impose some extra costs on borrowers in very
large mortgages, but I do not think in most cases that they
will be squeezed out of the market. So they are some of the
tradeoffs that the GSEs and the Congress are looking at.
Senator Akaka. Thank you, Mr. Chairman.
Chairman Johnson. Senator Kirk.
Senator Kirk. Thank you, Mr. Chairman.
Mr. Chairman, I have three quick issues I want to raise
with you, and I will put them all on the table.
First, my understanding is that, according to Terry Zivney
and Richard Marcus in Federal Review, August 1989, we had a
technical default of the United States April 26, May 3, and May
10, 1979, when the United States could not pay individual bond
holders holding Treasuries on time, and my understanding is it
was about a 60-basis-point rise in borrowing costs to the
Federal Government. If you could talk about when we defaulted
last time, 1979.
Second, I understand that Italy just tried to borrow money
twice today. Their 5-year benchmark had a 21-percent increase
in the cost of borrowing over last year, just went out at 4.9
percent, up from 3.9 percent a year ago. And they set a record
on their 15-year borrowing. They paid the highest interest rate
ever at 5.9 percent. And we are seeing a real M1 decline in
Italy, and my question is: Should we have a kind of Greek-style
bailout for Spain and Italy? The Congressional Research Service
estimates that the IMF is $50 billion short.
And, last, I am worried about the long-term finances of
especially my home State of Illinois and California, and given
their pension liabilities, Illinois being the lowest-paid
pensions in the United States, do you see a systemic risk posed
by these two States to the municipal finance and bond sector
for the United States?
I lay all three of those issues out for your comment.
Mr. Bernanke. Sure. Thank you. It is true that in 1979,
mostly because of mechanical problems, operational problems,
there were a few Treasury bills that did not receive interest
payments on time. Interest rates did go up there, but it is not
entirely clear whether it was entirely due to the default or
whether it was due to some other factors, like changes in
expectations of monetary policy, for example.
I do not think it is really comparable to the current
situation because this was just a couple of isolated issues,
and, in fact, the Wall Street Journal did not even report that
this had happened. People did not generally know that this had
happened. So it was not viewed as something that was a broad-
based risk to the financial markets.
On Italy, it is true there has been a bit of market jitters
there, and the kind of concern you worry about is exactly this
kind of vicious circle that we are worried about in the case of
the United States, where loss of confidence raises interest
rates, that makes the deficit worse, and it makes it just even
more difficult to get fiscal stability.
My sense of Italy is that certainly the first line of
defense is for Italy to take the necessary steps. It is true
that Italy has a very high debt-to-GDP ratio, but it has some
strengths. Notably, it currently has a primary surplus, that
is, excluding interest, it actually has a small surplus, so its
fiscal position in terms of the current deficit is much better
than Greece, for example. Its banks are in decent shape. They
have taken some extra capital in recently. It has got a well-
diversified, manufacturing-based economy. So there are a lot of
strengths that it has, so I think the first line of defense,
perhaps with some assistance or commitments from the Europeans,
would be for Italy to try to address the concerns that the
markets have.
In terms of explicit debt, States do not generally have the
same kinds of levels of debt that our U.S. Federal Government
or European governments have, and they rely on Federal money
for Social Security, for medical care, and other things. So
there are some States--Illinois, California, as you mentioned--
that are having more difficulty. We watch those very carefully.
We also look at the exposures of banks and other institutions
to those States. We do not see any immediate risk there, but it
is true that a number of States do need to be thinking about
their longer-term sustainability given the unfunded liabilities
they may have for State pensions and for in some cases the
health care programs as well. But we are monitoring that
situation, but we do not think it is really analogous to the
European situation.
Senator Kirk. I have got 13 seconds to go. What about the
adequacy of the IMF should we face a Spanish and Italian
contingency? Are you concerned that at Greek bailout levels we
would run about $50 billion short?
Mr. Bernanke. Spain and Italy are much bigger economies
than the three that have already been addressed, and if it came
to that point, I want to be very clear that I do not anticipate
that happening. But if it came to that point, I think the
Europeans would have to make a very substantial contribution to
stabilize those countries.
Senator Kirk. Thank you, Mr. Chairman.
Chairman Johnson. Senator Kohl.
Senator Kohl. Thank you very much, Mr. Chairman.
Nice to have you with us this morning, Mr. Bernanke. I
would like to ask you about our job situation and our recovery
and their interrelationship. We have a jobless recovery by many
people's estimate. Even as the economy seems to be getting
better and profits in corporations are stronger, hiring has not
been what we want it to be, and, of course, wages are not what
we want them to be. The wage picture in particular is
disturbing because average wages in this country, family income
has not moved in many years. And as companies continue to
progress and not hire, what we are finding is that they are
able to do business at a higher level with the same number of
employees, in some cases even fewer employees.
So I am asking myself, How do we turn this around? And when
is this going to get turned around? Back in other times, there
was a much more direct correlation between economic activity,
rising profits and growth, and hiring and wages. We do not seem
to have that connection today.
I would like you to comment on that and what that portends
for us even as business gets better.
Mr. Bernanke. Well, I can only agree with your diagnosis.
We have high unemployment. It is improving very, very slowly in
terms of jobs regained. We have the potential for very long run
consequences because of the long-term unemployed. Those folks
are going to find it much harder to find new work or find work
that was comparable to the work they had before. Wages are very
stagnant, and that is affecting consumer spending and consumer
confidence. So I agree absolutely this is a major problem.
There has been a tendency in the last 20 years or so for
recoveries to be more jobless in the early post-war period. We
saw the same thing in the 1990s and the beginning of the last
decade. There is a little bit of an irony here, which is that,
generally speaking, productivity gains are a really good thing
and that helps make the country rich over time. But over very
short periods in this crisis, a lot of firms got very scared.
They reduced their labor forces, and they tried to find ways to
produce the same output without as many workers, and in doing
so they increased productivity remarkably. But given the low
level of demand, that means that their demand for workers is
not as strong as we would like.
There is also ongoing uncertainty about the durability of
the recovery and about the economic environment, including
fiscal issues, as we have been talking about. So if I had the
answer, I would give it to you. The Federal Reserve has been
providing as much accommodative support as we can to meet our
dual mandate. I do think it would be worth Congress looking at
some specific issues related to the unemployed. I am concerned
about the long-run implications of the long-term unemployment.
Are there things that the Congress could do to help people
improve their skills or to find new opportunities? I think
those are questions that should be asked.
Senator Kohl. And it is also very troubling, isn't it, that
family wages have just stagnated, not just for the last year or
two but for the last decade or longer. And unless we can find a
way to turn that around, we are looking at a troubling future,
to say the least. After all, the economy is driven by consumer
demand, and if wages are not increasing in spite of a stronger
economy, let alone employment, if wages are not increasing, we
are facing a very troubling future. Wouldn't you say that?
Mr. Bernanke. Yes, and it is a long-run trend. It is a 30-
year trend.
Senator Kohl. Right.
Mr. Bernanke. And one part of it is skills and preparation.
We have a globalized, highly technological society, and those
people who are prepared for it can do very well, but it used to
be if you had a high school education, you were prepared to get
a decent job, but now that is not nearly the case.
Senator Kohl. Right.
Mr. Bernanke. So we are going to have to address those
education deficits and help people get the skills.
Senator Kohl. Can I ask just one more question?
Mr. Bernanke. Sure.
Senator Kohl. Consolidation of the banking industry is not
new, but it is certainly something that I am thinking about at
this time because last week, after 164 years in Wisconsin, the
M&I Bank was bought out by Harris Bank, a subsidiary of the
Bank of Montreal. M&I was Wisconsin's largest and oldest banks,
and now it has been purchased, as I said, by a national bank.
One concern I have with larger national banks moving into
Wisconsin is what impact that will have on local customers,
small businesses, and farmers. We have seen evidence that
mergers of smaller banks can be good for small business, but
when a large national bank buys smaller banks, small business
loans tend to decrease. That is the statistic.
As more national banks acquire regional and community
banks, what can we do to see to it that they keep lending to
small businesses? Is the Federal Reserve looking at the impacts
of consolidation on lending to small business and farmers?
Mr. Bernanke. Yes, Senator, we are. We and the Department
of Justice are typically involved in approving mergers and
acquisitions, and when we do that, one of the key exercises we
do is we look at the resulting concentration of banking
services within the local area, within a city, within a county.
And we want to be sure, when taking into account all the
banking services, thrifts, and others that are in that area,
that any merger or acquisition does not create a situation
where one firm dominates that market. And so we do pay a lot of
attention to making sure that there is competition, that
consumers and businesses have alternatives to go to within
their local market when we approve those mergers.
It is true that larger banks, particularly recently, have
been not as forthcoming with small business as some local
banks, community banks have been. And we see a lot of advantage
in community banks, and we are very supportive of community
banks. We have a subcommittee in our supervisory function which
looks entirely at the implications of new rules and regulations
for smaller banks and tries to do whatever we can to minimize
the burden on those banks. We would like to see a healthy
community banking system, and we are going to do our best to
support that goal.
Senator Kohl. Thank you very much.
Chairman Johnson. Senator Johanns.
Senator Johanns. Mr. Chairman, good to see you again.
Mr. Chairman, as we have been working through the
challenges of the debt ceiling and August 2nd--and maybe August
2nd is actually August 3rd or August 4th--I have been trying to
do as deep a dive as I can to understand the cash-flow and the
financial requirements of the U.S. Government. And so I am
hoping I can use my 5 minutes to offer hopefully some insight
on that, but I would like your reaction to a couple of things
that I think I have identified here that are enormously
important.
The first thing, I looked at the indebtedness of the United
States, the Treasuries, the Treasuries we issue, and on August
4th, we need to roll over $90.8 billion; August 11th, $93.3
billion; August 15th, $26.6 billion; August 18th, $87 billion;
August 25th, $112 billion; and August 31st, $60.8 billion.
Let us say that, for whatever reason, there is no solution
to this raising the debt ceiling issue through August and we
are constantly in the market, as you know, trying to deal with
the Treasury situation. We have got these that we have to roll
over. What is the market reaction going to be just in terms of
this? It just seems to me that if I were a big trader in
Treasuries, I would want a better deal. I would want more
interest. I would want something from the U.S. Government,
because all of a sudden there is an element of political risk
that has been injected that maybe there will not be enough
consensus to deal with this.
What is your reaction to that?
Mr. Bernanke. Senator, you are absolutely right. We know
what our interest payments are going to be, but we have to roll
over large amounts of Treasuries, and it could be that if
investors demand higher interest rates, that means basically
that we will be short, that the price that will be paid will be
less than we need to borrow, so that is another source of
uncertainty in terms of what we are going to owe from the
coffers of the Treasury.
So, yes, I think that it is very uncertain, and we are
seeing already the downgrade threats and so on. But it is
entirely possible that a loss of confidence or political risk
could raise interest rates and would effectively make it more
difficult or at least more expensive to roll over the debt
going forward.
Senator Johanns. Now, in terms of that rollover, my
understanding is we cannot avoid that without really severe
consequences. In other words, as these dates come up, we have
got to deal with it. Is that a correct assumption, or are there
alternatives I do not know about?
Mr. Bernanke. When the principal comes up, we have to roll
it over or sell other bonds to meet that amount.
Senator Johanns. OK. Now, the next piece of this--and,
gosh, there was so much discussion out there about whether
Treasury could do this and Social Security recipients will, in
fact, get paid or whatever the latest point is. But I was
looking at an analysis that was done, again, for August, and it
anticipates revenues of $172.4 billion. I admit there could be
some give and take on that. Outflows--in other words,
requirements for money--of $306,713,000,000. So obviously we
know we are borrowing 40 cents on every dollar. Less is coming
in than we have got obligations for August.
But I looked at the requirements in August: interest on
Treasuries, $29 billion; Social Security, $49 billion;
Medicare, $50 billion; defense vendor payments, $31 billion;
unemployment benefits, $12 billion. So if you just paid those
items, you would spend $172 billion; in other words, you have
spent the money that came in. And since we have not raised the
debt ceiling, that is it.
Now, there is a whole list of items under that that are not
getting paid, and you might move some of those up. But it is
pretty awful: Veterans Affairs programs; we have not made
payroll for the Federal Government; that does not include
military pay, although many would argue it should be above the
line.
How will the market regard us--let us say we can deal with
this Treasury issue. How will the market regard us not paying
this long list of other financial obligations? They are not
securities, but they are truly financial obligations.
Mr. Bernanke. Well, Senator, nobody knows with certainty,
which is part of the reason why we should not be taking this
risk in the first place. But it seems to me very reasonable to
expect that a government that shows it is unwilling to pay its
bills, pay its obligations, would engender some distrust in the
markets and that we would still see response of interest rates
and increased financial volatility.
I should say once again that this is a hypothetical
discussion because Treasury takes the view that it is not
appropriate or feasible to prioritize in that strict way that
you described.
Senator Johanns. I will just wrap up with one last comment
because my time has expired. For me, this is mathematics. So
much money comes in, so much money goes out. It is mathematics.
It is not magic. My hope is that between now and whatever date
Treasury, you, others will descend upon the Hill to do what I
have done, to avoid some of the discussion that, quite
honestly, maybe is not just fully accurate--and I do not want
to accuse anybody of anything, but I think this would be very
helpful to understand the math.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Bennet.
Senator Bennet. Thank you, Mr. Chairman.
Just to follow up on Senator Johanns' line of questioning,
first, Mr. Chairman, and I do not mean this in a technical
sense, but isn't there a huge risk if we announce to the world
that we cannot raise the debt ceiling, that we are so
politically dysfunctional that there is no plan, that the
market would treat our lack of payment on any of these
obligations as a cross-default, in effect, with the debt, and
then we would see interest rate rates rise very quickly as a
result of that.
Mr. Bernanke. Again, nobody knows for sure, but that is a
possibility. And I would just add that nobody thinks the United
States cannot pay its debts. It is really a political risk, not
a----
Senator Bennet. It is a political risk.
Mr. Bernanke. It is not an economic risk.
Senator Bennet. Exactly. It is a political risk. No mayor
in my State of Colorado would ever threaten to jeopardize the
credit rating of his city. He would be run out on a rail for
doing it. And we find ourselves in this position.
I wanted to ask a question that--and, by the way, we are
not focused on the things that Senator Kohl was talking about,
which is what the people in my State want to know: how we are
going to create an economy where median family income is
actually rising instead of falling and what we are doing to
create jobs. I appreciate that line of questioning.
Moody's said yesterday:
An actual default, regardless of duration, would fundamentally
alter Moody's assessment of the timeliness of future payments,
and a AAA rating would likely no longer be appropriate.
Can you remember the last time a credit rating agency
threatened a downgrade of U.S. debt?
Mr. Bernanke. It has happened recently.
Senator Bennet. Before this.
Mr. Bernanke. But before this?
Senator Bennet. It happened recently in the same context
that we are in today.
Mr. Bernanke. The current context, yes.
Senator Bennet. Right. When was the last time before this
debate about raising the debt ceiling arose?
Mr. Bernanke. I do not think that has happened in the 20th
century, but I am not certain.
Senator Bennet. We are now in the 21st century, so it has
not happened in the 21st century, it has not happened in the
20th century.
Mr. Bernanke. I do not believe so.
Senator Bennet. This Congress has put ourselves in this
position where credit ratings are actually threatening our
credit rating.
Mr. Bernanke. That is right.
Senator Bennet. Can you think of an asset that is more
important to us than our credit rating? When you think about
the----
Mr. Bernanke. Well, there are many assets, but clearly
the----
Senator Bennet. That gives us more competitive advantage
than our credit rating?
Mr. Bernanke. It is tremendously important that we have the
confidence of the world in terms of willingness to hold
Treasuries, to trade in Treasuries, to maintain a liquid market
in Treasuries for the stability of the dollar. It is a very
important asset, and losing that credit rating is a self-
inflicted wound.
Senator Bennet. Mr. Chairman, am I over time? I am confused
about the clock? Did we reset it?
Chairman Johnson. Yes, it has been reset.
Senator Bennet. Thank you. I still have time left.
I want to come back to the question of what the effect of
losing that credit rating would be--not on our interests cost
in the Government because we know they would--the effect would
obviously be devastating, but the effect on people living in
the State of Colorado. You generally talked about how interest
rates--but if you could specifically say to people in my State,
what does it mean to me when I go to buy a car or to get a bank
loan or to buy my house or to go to the grocery store? What is
the effect on me if people wake up in August of 2011 and our
debt has been downgraded by these rating agencies and we do not
have a political path forward to address the problem?
Mr. Bernanke. Well, Treasuries are the benchmark security.
Most other interest rates are priced off of Treasuries. So if
5-, 10-year Treasury yields were to go up by 2 percentage
points, then you would expect to see mortgage rates go up
immediately by 2 percentage points, and likewise with other
borrowing costs that firms and households face.
There would also very likely be an impact on the economy,
which would then affect jobs and consumer income as well.
Senator Bennet. What do you mean by ``affect jobs''?
Mr. Bernanke. Higher interest rates, uncertainty, fiscal
contraction--all those----
Senator Bennet. Higher unemployment.
Mr. Bernanke. It would lead to higher unemployment.
Senator Bennet. It would lead to higher unemployment. The
unemployment rate today is 9 percent.
Mr. Bernanke. Correct.
Senator Bennet. Can you think of a greater self-inflicted
wound that we could manage to accomplish through our
dysfunctionality than drive our unemployment rate higher when
it is at 9 percent?
Mr. Bernanke. We certainly do not want to take an action to
threaten our credit rating or to drive up our interest rates,
which is counterproductive to the goal of reducing the deficit.
Senator Bennet. Well, that was where I was going next.
Mr. Bernanke. Right, right.
Senator Bennet. Which is, if all you cared about, if the
only thing--the sun rose in the morning and it set at night and
the only thing you were thinking about was our deficit--which
is of huge concern to me. I have spent a lot of time on the
floor talking about it. I have got kids that I am worried
about, and we have got to get a hold of it--we really do--in a
bipartisan way. Can you think of anything that would be more
destructive to my desire to pay down our deficit than to fail
to raise the debt ceiling--raise the interest rate?
Mr. Bernanke. You tax my imagination.
Senator Bennet. I tax your imagination.
Mr. Bernanke. Yes.
Senator Bennet. Even economists have imaginations.
Mr. Bernanke. Even some.
[Laughter.]
Senator Bennet. But, you know, in all seriousness--in all
seriousness--we are sitting across the table from you saying:
I am deeply concerned about the fiscal condition of this
country, I am deeply concerned about the size of the deficit.
Can you think of anything I could do that would be more
problematic than jeopardize our credit rating?
Mr. Bernanke. That would certainly be a very negative
thing, and this is happening at the same time that Europe is
dealing with fiscal issues, so there is just a lot of
uncertainty piling on each other globally.
Senator Bennet. Right. Exactly. So here is the last thing.
We are just emerging from the worst recession since the Great
Depression, and we went into this recession--we sort of went
straight off the cliff. A lot of people did not predict it. A
lot of people could not see that it was coming. How do you
assess the risk that if we end up driving this car over the
cliff with our eyes wide open, which they are, we could see a
downturn in our economy at a point when our deficit is already
at $1.5 trillion, which it was not before the last recession,
when your balance sheet is now $3 trillion, which it was not
before the last downturn, that this economic crisis could be at
least as bad as the one that we just came out of, and that the
policy responses that are available to you and to the Treasury
and to the Congress are actually more limited at this point
because we are still recovering from the last crisis we went
through? Could you talk that through a little bit? What would
it look like on the other side if we actually do get to a place
where we find ourselves in this utterly predictable----
Mr. Bernanke. Well, it certainly could slow the economy
through higher interest rates and through financial volatility,
but you actually make an additional point which I think is
worth emphasizing. The higher interest rates would add to the
deficit, but also a slowdown in economic activity by reducing
revenues would also further add to the deficit. So it really is
going in the wrong direction in terms of fiscal stability.
Senator Bennet. Thank you, Mr. Chairman. I apologize for
going over.
Chairman Johnson. Senator Corker.
Senator Corker. Mr. Chairman, thank you for being here, and
I will continue, as has been the tradition this morning, to use
you as a prop to make our own points.
[Laughter.]
Senator Corker. But thank you for your willingness to
participate in that manner.
The fact is that all this talk about the debt ceiling is
farcical at this moment. I think we all know that our
leadership has concocted a scheme where folks on the other side
of the aisle can allow the debt ceiling to increase and
continue to appeal to their constituencies for the 2012
election, and on our side, we can continue to cause spending to
be an issue for us in the election, and basically by virtue of
concocting this scheme, we are not going to make any tough
decisions. We all know that. And maybe the debt ceiling was the
wrong place for us to be making that argument.
But let me move to the other side of this. It is evident
the debt ceiling is going to be increased. It is probable that
not much is going to occur as it relates to spending. And I
would say that the flip side of this is people have to be
waking up at some point when we go through this whole short-
term hurdle and say, you know, on the other hand, if the U.S.
Government does not do something as it relates to spending,
then the credit rating agencies--as a matter of fact, some of
them have already referred to that, not this debt ceiling
issue, as being a major problem. Would you agree?
Mr. Bernanke. Yes, Senator. I want to be clear. Whenever I
have talked about this, I have had a two-handed economist
approach, which is the debt ceiling needs to be addressed, but
we also do need to address the stability and sustainability of
our fiscal position.
Senator Corker. Yes. So let me, since you are a prop and
you are answering the way we all want you to answer, I guess
the debt ceiling is probably not the best place for us to deal
with this issue. What is the best place for Congress to
actually deal with the issues of spending?
Mr. Bernanke. Well, through the legislative and
consultative process that the Founders----
Senator Corker. Is it called a budget?
Mr. Bernanke. Well, except for one thing----
Senator Corker. The answer is supposed to be yes----
Mr. Bernanke. Sorry.
[Laughter.]
Senator Corker.----if you are an appropriate prop for us.
Mr. Bernanke. I will. My only point was just to say, the
answer is yes, but we need to think about this both in the
current year and also on a longer-term basis.
Senator Corker. Future years, I agree.
Mr. Bernanke. Yes.
Senator Corker. So let me just--you know, we basically--I
do not know what the most common joke is around the Fed about
most of us around here. I would love to hear it maybe sometime
if you will not do it with a microphone today, but we basically
have been sort of feckless Members.
The U.S. Senate has basically caused this great Nation to
be in decline because we are not willing to deal with the tough
issues we need to deal with. So some people resorted to the
debt ceiling, and that is obviously--we figured out a political
solution to that that works well for both sides to be able to
campaign through 2012. But the fact is, we have not dealt with
a budget now for some time.
The majority party could actually be mostly criticized for
that, but I do not want to do that. I think both sides are
critical, because now we are moving to a spending bill today
without a budget. And so all these--this has been a lot of fun,
for everybody to use you as their prop about the debt ceiling,
but the fact is that we are all sort of two-bit pawns in all of
this by allowing our country to continue to spend money.
What has happened is our leadership has wanted to protect
us. You see, we have to make tough decisions when we budget and
prioritize. And so in order to protect majorities, we do not go
through that process. How do you think--being the good prop
that you are--how do you think the financial analysts view our
inability to make those tough decisions?
Mr. Bernanke. Well, as I indicated, I think they view this
whole situation, both the debt ceiling situation and the long-
term fiscal stability situation, as being a political issue and
not an economic issue. The question is whether or not we can
come together and find real solutions. I think some of the
discussions that have been had suggest that some very large-
scale fixes could be undertaken. I am not prescribing one or
the other. But we need to do something very significant just to
keep our debt-to-GDP ratio from rising over the next decade,
and then after that, we have entitlement issues, as well. So we
need to do something big, strong----
Senator Corker. I had dinner Monday night with a number of
my colleagues on both sides of the aisle, and I will not
mention who they were to impugn them, but all complaining about
how dysfunctional this place is, and yet today, I am going to
use this opportunity to point out that we are moving to a
spending bill without a budget. So any of us who complain about
how dysfunctional--and my friend used the word
``dysfunctional;'' I use it often, unfortunately--any of us who
complain about how dysfunctional the U.S. Government is today
and the fact that the Senate is moving our country into decline
who would then vote for a spending bill without a budget are
basically accomplices in allowing us to move toward that place
that you are talking about where the credit rating agencies are
going to be downgrading us because we do not make tough
decisions.
My time is up and I appreciate you--basically, when you are
the second day of Humphrey-Hawkins, there is really not much to
talk about other than what we want to put forth. I do want to
close with this.
I thank you for your service and I respect you and I
appreciate the way the Fed has been with me very open, very
transparent. You shared confidences with me that I have keep
confidential and I have appreciated that. I will tell you that
I find the activism at the Fed right now a major turn-off and I
am very concerned. As one person who I think we have had a good
relationship, I want to tell you that I am quickly moving to a
camp that wants to clip the wings of the Fed, because I do
believe that the activism there is distortive of the market,
and I believe that the dual mandate that we have set up is
causing you--something is causing you to do a lot of things
that I think are going to create some long-term damage.
So just know that while I respect you and I respect
certainly the people who work with you and I appreciate the
kindness, I am extremely turned off by your activism.
Chairman Johnson. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Chairman Bernanke, thank you again for your service to our
country. You know, you and I at different times here have
spoken about the 2008 crisis and the reality that, but for the
Congress acting, we would have maybe not been in the deep
recession we are in but on the verge of a near depression. And
as that as a backdrop, I look at past recoveries which were
first led by a surge in the home market, home building, and
then by the easing of credit, and with the high number of
distressed homes on the market creating a crippled housing
construction sector and with financial firms still cautious as
they rebuild their capital base, is this the best recovery we
could have expected? And, second, given those persisting
problems, do you really think, or are there policies that can
create a stronger recovery with many more jobs?
Mr. Bernanke. I do not see any easy solutions, obviously. I
certainly would have recommended them if I saw them. Senator
Corker alluded to activism. I think what we are trying to do is
to fulfill our mandate, which is to provide as much support as
we can for the recovery.
On the fiscal side, I recognize there are some real
tensions because there would be scope for targeted programs to
help some of the issues that we have in housing and otherwise.
But I understand the concerns on both sides of the aisle about
the long-term fiscal stability of the country and the need to
address those issues. So it is a difficult situation. We do not
have any substantial unused capacity to increase the speed of
the recovery.
Senator Menendez. And so it is a difficult situation
stemming from where we started, because there is always a
starting point here.
Mr. Bernanke. That is right.
Senator Menendez. And so I look at, you know, a combination
of tax cuts that went unpaid for and deprive the Treasury of
enormous amounts of money at a time that we had two wars raging
abroad in Iraq and Afghanistan, also unpaid for, a new
entitlement program passed in the past Congress that is unpaid
for, and a Wall Street that instead of being a free market was
a free-for-all market. And you put that all together and that
is what we are coming out of.
So I am wondering--your answer to me suggests that there is
not any more monetary policy that is going to come forward that
could, in essence, seek a more faster, more robust recovery
with a greater job growth.
Mr. Bernanke. Well, as I said in my testimony, given that
there is a lot of uncertainty about how the economy will
evolve, we have to keep all options, both for tightening and
for easing, on the table, and we are doing that. But again, we
are already providing an exceptional amount of accommodation.
As you know, recovery is still pretty slow.
Senator Menendez. Now, I want to turn to the question of
the debt ceiling. I know you have discussed that quite a bit.
You know, I find it interesting. Under President Bush's years,
he raised the debt ceiling to the tune of about $5.4 trillion
during his period of time. I did not hear the same comments
then that raising the debt ceiling was something that was not
necessary to do, that, in essence, having the Nation be a
deadbeat is OK. And I find it alarming that there are people
running for high office in this country and others already in
significant positions who suggest that there is no great
concern to allowing the Nation to be a deadbeat, to default,
and no real consequences.
And so in pursuit of a solution, we have had these efforts
to have severe cuts, to consider entitlement changes, as well.
But I wonder whether entitlement changes should not also be the
question of entitlements. Somehow, it seems that revenues are
now an entitlement, as well. It seems that those who are the
wealthiest in the country, that major entities like the oil and
gas industry that is getting $21 billion in tax breaks when
they are going to make $144 billion in profits this year alone,
no, we cannot touch them. So it seems to me we have a new class
of entitlements.
Is not, in order to solve this problem, it really going to
require real shared sacrifice, because I look at GDP in this
country and about 70 percent of it is driven by domestic
consumer demand. Well, there are no jobs, there is no demand.
And if we are going to put this on the backs of middle-class
working families who spend more of their disposable income,
then I do not know how we are going to drive this economy based
upon your previous answer that there is not too much more
monetary policy we can have. Do you not think that it is fair
to consider a shared sacrifice that is spread across the board
to try to solve this debt ceiling question and the debt
questions that confront the Nation?
Mr. Bernanke. Well, Senator, I think you can appreciate I
do not inject myself into these negotiations, which are very
difficult and delicate, but I do hope that everything will be
on the table and that there will be frank and open discussion
about the tradeoffs and----
Senator Menendez. Well, as fiscal policy, do you believe
that only one section of the American society should bear the
burden? For example, is it overwhelmingly going to be the
middle class in cuts that affect their lives and may have to
reach into their pockets more at the end of the day that is the
way in which we achieve the right fiscal policy for the
country?
Mr. Bernanke. Well, I think that we want to have shared
sacrifice. We also want to make sure we maintain a strong
economy. There are a whole bunch of issues there. These are not
issues that a pure economic analysis can answer. These are
values issues and this is what elected officials are supposed
to be determining. I really cannot make those decisions for
you.
Senator Menendez. No, I am not looking for you to do that,
Mr. Chairman. I just think that we have come to a point in
which it seems that the tax code for those who benefit by it,
whether it be large corporations like the oil and gas
companies, whether it be the wealthiest millionaires and
billionaires in the country, they are entitled to keep those
tax breaks, but middle-class working families seem to be called
upon for the burden of the resolution of this problem, and to
me, that is both a moral issue, but it also is a fiscal issue.
It is the wrong process by which we achieve the balance we
need.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Vitter.
Senator Vitter. Thank you, Mr. Chairman, and thank you, Mr.
Chairman, for being here.
Moody's, in their recent outlooks, said that a credible
agreement on substantial deficit reduction would support a
continued stable outlook. Lack of such an agreement could
prompt Moody's to change its outlook to negative on the AAA
rating. Do you think that sort of statement about a plan for
deficit reduction is indicative of the entire market?
Mr. Bernanke. Yes, I do. As I have said, there are two
prongs here. One is to navigate this debt ceiling issue without
any kind of disruption, but the other, which would not be
successful, that we just kick the can down the road in terms of
our fiscal, long-term fiscal situation. So I very much support
a strong fiscal deal.
Senator Vitter. Right, and I have asked you previously how
quickly this lack of a sustainable fiscal path could bite us
and could have serious consequence, and I believe--I do not
want to put words in your mouth--I believe you said you do not
know, but it certainly could be sooner rather than later and it
is not necessarily years off. Could you make a comment on that
now?
Mr. Bernanke. No, that is correct. Markets are forward
looking. They are trying to assess the likelihood that they
will get paid years down the road. And we are seeing it in
other countries around the world, that there is a loss of
confidence by investors in a country's fiscal stability and its
political resolve to address those fiscal issues, that interest
rates can start to rise and then you get a vicious circle.
Senator Vitter. Right. So if the resolution of this present
showdown and negotiation is increasing the debt ceiling with no
significant change in terms of our fiscal path, how do you
think the markets will digest that?
Mr. Bernanke. Well, I am sorry the two things got linked
together the way they did, but I would very much like to see
both parts of this work, both addressing the debt ceiling and
addressing longer-term fiscal issues. I do not know how quickly
or in what degree the markets would respond, but I think they
are looking to Washington to show that they can manage their
spending and control deficits over a long period of time.
Senator Vitter. What you said a minute ago is part of my
point. We have been talking about this event for months and it
has been built up, smartly or dumbly, rightly or wrongly, as an
opportunity to do something. So particularly with that buildup
and that context, I guess my gut is that if we extend the debt
limit and essentially do nothing for fiscal sustainability, the
markets will have some sort of meaningful negative reaction as
reflected in the Moody's statement. Would you agree with that
or not?
Mr. Bernanke. It is possible.
Senator Vitter. Turning to other policy and talk of,
essentially, a QE3, I certainly agree with Senator Corker's
comments. I am sure that does not surprise you. What would you
point to in terms of success with QE1 or QE2 in terms of
suggesting and convincing us that a third round is advisable?
Mr. Bernanke. Well, QE1 came in, basically in March of
2009, which was at a very, very weak point in the recovery. It
was the absolute trough of the economy. The stock market was
about half where it is now. The first round seemed to restore
confidence and seemed to strengthen financial markets. It
helped the economy grow quickly in the latter part of that
year. And it was not the only contributor to the recovery and
improvement in financial conditions, but I think it was a
significant contributor.
QE2, as it is called, was first signaled in August of last
year, and as I mentioned in my testimony, at that time, we were
missing our mandate in the same direction on both parts of the
mandate. That is, employment was very weak. It looked like the
growth was so weak that unemployment might start to rise again.
And inflation, rather than not being inflation, was actually
falling down toward a very low level, and we know that we have
not experienced it here since the 1930s that deflation can be a
very pernicious situation.
So our policies, which are admittedly different from the
normal ones, they lower interest rates, they strengthen asset
prices, and they provide more incentive for people to borrow,
spend, invest. I think it obviously has addressed the inflation
issue, and we think that by the second half of the year, we are
going to be more or less on target in terms of where we want to
be in inflation. And although job creation has not been all we
would like it to be, it has been consistent with our
expectations of about 700,000 jobs over 2 years.
So we think it has moved in the right direction and it has
not had, if our forecasts are right and inflation stabilizes
around 2 percent in the second half of the year, then some of
these fears about hyperinflation and so on will have been shown
not to have been accurate. So we think it has been
constructive.
That being said, we are trying to maintain flexibility in
both directions, both in terms of easing and tightening. But we
recognize that monetary policy is not a panacea and we hope
that Congress will be addressing issues related to the economy,
as well.
Senator Vitter. Mr. Chairman, if I can just have one more
question to finish out----
Senator Reed. [Presiding.] Very quickly, sir.
Senator Vitter. Thank you. In that framework of promoting
growth, promoting recovery, what do you think the impact would
be if we announced today letting the Bush tax cuts expire at
the end of 2012 for the top brackets, so essentially a tax
increase for those brackets. What do you think the impact on
growth and the economy would be?
Mr. Bernanke. I cannot really assess that. It would have
some effects on higher marginal rates. It would have some
effects on incentives. Higher rates would also take some
consumer spending out of the economy. On the other hand, we
have all been talking about the importance of addressing the
overall deficit situation, so that would work in the other
direction. So it would have multiple, different effects on the
economy, and those kinds of specific policy decisions are going
to have to be worked out by the folks who were elected to do
that.
Senator Reed. Senator Hagan.
Senator Hagan. Thank you, Mr. Chairman, and Mr. Bernanke,
thank you for your testimony and thank you for your hard work
and all that you are doing right now.
Mr. Bernanke. Thank you.
Senator Hagan. I served for 10 years in the State Senate in
North Carolina, co-chaired our budget, and we did everything
possible to keep a AAA credit rating in the State because we
knew the consequences if we did not, the increase of our
interest rates on our debt, and I just think the American
people deserve better than what they are seeing right now from
the lack of inaction--of the inability for Democrats and
Republicans to come together right now and help solve this
issue. So I am extremely concerned about it, as I know the
American people are, and I think we agree that failing to raise
the debt ceiling could create, obviously, tremendous problems
for our financial system and our economy that you have been
discussing today and problems that might require accommodative
monetary policy from the Fed.
I understand that the Federal funds rates, they cannot be
lowered in any other meaningful way, and that one of the Fed's
responses to an economic weakness would be to initiate more
securities purchases. I was just wondering, can you help me
understand what the Fed would do, how you would respond if we
went into default, and could the Fed purchase Treasury
securities that had defaulted?
Mr. Bernanke. Well, on that last question, that is really
an FOMC decision and I would have to leave that to that broader
group.
We would do what we could to preserve the operationality of
the system. We participate in securities transfers and so on.
But I want to eliminate any expectation that the Fed through
any mechanism could offset the impact of a default on the
Government debt. I think that it would be a very destructive
event, and while the Fed would do what it could, again, I do
not think it is fair to have any expectations that we could
offset the impact of that.
Senator Hagan. How would this impact the Fed's ability to
conduct monetary policy?
Mr. Bernanke. Well, it would immediately offset a lot of
the benefits from our policy by causing interest rates to rise
and that would effect the state of the economy. It would also
likely create disorderly conditions in money markets and so on
where we do actually move interest rates around. So it would be
counterproductive, certainly, to the goal of restoring a
healthier economy.
Senator Hagan. What happens to the Fed's income and its
distributions to the Treasury if the Treasury stops making
timely payments?
Mr. Bernanke. Well, that part is kind of a wash with
respect to the Fed's payments because we receive interest from
the Treasury and then we remit most of it back to the Treasury.
So I think our greater concerns would be the impacts on the
financial markets.
I think it is important to understand that Treasuries are
not just a buy-and-hold asset. They are used for margin, for
collateral, for liquidity, for hedging, for a whole variety of
different functions. They are the fundamental element that
keeps the financial system moving. And so there would be a
great deal of disruption in the private sector in the financial
markets, and that is where I think the main problems would
occur.
Senator Hagan. Chairman Bernanke, I cannot tell you how
alarmed I was on Friday of this past week when the Bureau of
Labor Statistics released the employment report and there are
over 430,000 people unemployed in my State now that are looking
for work. And the bottom line of the creation of 18,000 new
jobs nationwide is obviously very disappointing to everybody.
I am very concerned, too, about the persistently high
unemployment rate among veterans. We have quite a few veterans
in North Carolina, and over 13 percent of these veterans are
currently unemployed right now. And it seems that we have got a
serious problem in the short run when it comes to unemployment,
and we have all been talking about that today, too. I believe
it is a problem that we do need to separate from the longer-
term fiscal imbalance that we are attempting to address.
What can be done in the short term to boost demand, help
get our citizens back to work? And I would be interested to
hear what you think of different policies that maybe have
worked in the past or any policies and thoughts that you might
have going forward.
Mr. Bernanke. Well, we were very disappointed, as well, and
as I said, we think it is partly temporary. We hope it is going
to be a little better going forward.
We have to think of fiscal policy as a whole. It is a
complicated problem because we are trying to maintain several
objectives at the same time, and one is we want to achieve a
long-term credible stabilization of our fiscal policy and
reduce deficits. We want to do that in a way that is going to
promote growth. We want to have a better tax system. We want to
have good investments made by the Government and so on.
But I also think we need to be a little bit careful about
the very short term because the recovery is still fragile and,
you know, very sharp cuts in the very short term could pose
some risk to that recovery. So I hope that all those different
goals can be combined in trying to solve this overall problem.
Again, the Fed is doing what it can to support the
recovery. Congress might want to look at some targeted
programs. For example, one of the issues that we have been
talking about is the effects on skills of long-term
unemployment. Veterans have perhaps been out of the labor force
while coming back. So one thing to look at, and again, there
are many different ways to do this, using the private sector
and so on, but one thing to look at would be what can we do to
help unemployed workers refresh their skills so that they will
be available and eligible for employment when job opportunities
arise.
Senator Hagan. I actually have a bill on that, and I was
not using you as a prop, either.
Mr. Bernanke. As a prop. OK. Thank you.
[Laughter.]
Senator Hagan. Thank you, Mr. Chairman.
Senator Reed. Senator Wicker.
Senator Wicker. Thank you, and thank you, Chairman, for
your testimony this morning and also yesterday, which I watched
part of.
I think a number of us on both sides of the table are
asking the question that is on the minds of Americans, and that
is, where is the recovery and why is the economy not doing any
better?
In your testimony on page 2, you say that Open Market
Committee participants see the first-half slowdown as
persisting for a while, and you mention at least four
headwinds: number one, slow growth in consumer spending; number
two, continued depressed housing sector; number three still-
limited access to credit for some households and small
businesses; and, number four, fiscal tightening at all levels
of Government.
Let me ask you, isn't it a fact that another headwind
affecting our economy and helping to cause this slowdown to
persist is the daunting slew of regulatory requirements,
particularly on financial institutions, in the past few years?
We have got the Basel capital requirements, enhanced
examinations of institutions, multiple new regulations under
Dodd-Frank. Has any attempt been made by the Fed or some other
entity, by FSOC, to add up the cumulative cost of these
regulatory burdens?
Mr. Bernanke. Well, what the Federal Reserve does is that
for each rule that we promulgate, we do a cost/benefit
analysis, which is part of our practice and required by law,
and we do our very best to make sure that we interpret the
statutes in a way that will be effective but will also minimize
the costs on the financial system. So we are doing what we can
to assess the costs and benefits.
It is a very difficult balance, I agree. On the one hand,
we certainly want to have credit flowing, and we want to have a
strong financial sector, and I think we will have a strong
financial sector. But we cannot forget where we were 3 years
ago when the financial system almost collapsed. And we are
still seeing the damage from that.
So we are trying to apply rules in a way that will minimize
the risk of another crisis and still permit good loans to be
made to creditworthy borrowers.
Senator Wicker. But you concede that credit is not flowing
as it should be.
Mr. Bernanke. In some areas it is, but in small business
and some household areas, not like we would like. Part of it is
the financial condition of the borrowers because they have
suffered through the recession or the value of their house or
collateral has fallen that they are not qualified. But
certainly there is still some tightness in some areas, that is
correct.
Senator Wicker. And small business is where jobs are
created.
Mr. Bernanke. Small businesses are an important part of job
creation, yes.
Senator Wicker. I appreciate that you said you do a cost/
benefit analysis on each individual regulation. How about
looking at doing a cost/benefit analysis of the cumulative
effect of all the regulations taken together? I think it is
possible that you might find that at some point these expected
benefits of addressing the problems of 2008 become such a
burden that actually the cost is too great and credit shuts
down.
Mr. Bernanke. Well, to do that, we would have to understand
the interactions, and we do try to understand those
interactions between different rules. But that is difficult. I
understand your point and am sympathetic with your point. But
once again, we do know that a financial crisis can be
extraordinarily costly, and so we want to take that into
account as well.
Senator Wicker. And one final question. Do you see any
particularly negative effect of a short-term increase in the
debt ceiling given the negotiating impasse that has occurred so
far? Would it be particularly disadvantageous to our credit
rating if we agreed to a ceiling last until early next year,
for example?
Mr. Bernanke. Well, it would be certainly advantageous not
to put us in a situation where we are threatening to default or
not make other payments. That would be----
Senator Wicker. It would be far better than no agreement at
all, would it not?
Mr. Bernanke. I think it would, but as Senator Corker
pointed out, or Senator Vitter, the other part of this is we
also want to make substantial progress on the long-term fiscal
situation. And if the rating agencies felt we were just
abandoning that effort, that would not be so good either. So we
want to make a convincing case that we are continuing to try to
find solutions to our fiscal issues.
Senator Wicker. And I would share that. I think speaking
for this side of the aisle, we would continue that, but clearly
rather than have the situation blow up, a short-term is not
something you would walk out of the room about, is it?
Mr. Bernanke. Well, my first best is that the debt limit
gets increased promptly and that we have a real solution for
our longer-term fiscal problems.
Senator Wicker. Thank you.
Thank you, Mr. Chairman.
Senator Reed. Senator Tester?
Senator Tester. Well, thank you, Senator Reed, and you for
being here, Chairman Bernanke.
Real quickly, I think we all understand we have a fiscal
problem in this country. We can keep kicking the can down the
road forever. The problem is if we want stability,
predictability, dependability, if we want the markets to react
like they can, we need a long-term plan. Correct?
Mr. Bernanke. Correct.
Senator Tester. Thank you. I want to talk about housing.
One of the areas of particular concern to me continues to be
the housing market. I know it is of concern to you. It is
weighing heavily on our ability to recover. In fact, earlier I
think you told Chairman Johnson it is the epicenter of the
problem.
The loan servicers, some of them are square in the middle
of this, and I think they have taken a role in creating it.
They did not seem very interested in solving the problem until
they were associated with the problem, to a large extent. We
learned about robo-signing, which you know about, not double-
checking the facts; in fact, in some cases even selling
mortgages they did not even own.
The result has been in my State, and I think probably
throughout the country--you would know this better than I--that
we have got some folks that are being foreclosed on without
good reason. In fact, that kind of attitude is not healthy for
our recovery, and it is not going to cut it.
We have got a number of reports about different settlements
that address the liabilities associated with toxic mortgages.
One bank recently announced $20 billion. There is another
report as large as $30 billion between State and Federal
prosecutors.
It is apparent to me--and I would like to get your opinion
on this--that some of the same guys that we bailed out in the
interest of stabilizing the markets are the ones who have made
the housing market far worse than it has to be. The market is
tied in a massive knot, and banks have made little progress in
untying it.
You have performed a second round of stress tests earlier
this year--correct--to determine the ability of many of these
servicers to withstand tough conditions? Can you give me a
sense of the scope and the magnitude of this problem and the
challenge it poses for the housing market and if, in fact, this
second round of stress tests have indicated whether these
servicers really have the ability to get their act together and
move forward in a way that can do positive things for the
housing industry?
Mr. Bernanke. Well, Senator, the stress tests actually bore
on the broader capital levels of these institutions, not
specifically on the servicing part. We had an investigation of
the servicing concerns jointly with the other banking agencies,
and as you know, we found many bad practices. I agree with your
characterization. It is just very poor business, very poor
practices in terms of making sure that consumers were
contacted, that they were appropriately treated, that all the
legalities were observed, et cetera.
The Federal Reserve together with other agencies has
imposed an order on the servicers to fix up their act and to go
back and look at every foreclosure going back for some number
of years and to compensate anybody who was injured by their
practices. And we will be imposing civil money penalties at
some point.
Senator Tester. That is good. I will tell you that some of
the folks that dealt in my office--and, by the way, there are a
lot of folks who did not call my office, and they should not
have to call a U.S. Senator's office to get results. But I can
give you an example of a man who was widowed and was about to
be kicked out of his house, and within weeks of doing it by one
of these servicers. Absolutely ridiculous. So I think you need
to help hold the people accountable, and if we can be helpful
in that, we will.
The housing market, it is in a knot. What can you do to
help unwind it?
Mr. Bernanke. Well, from the Fed's perspective we are
trying first obviously to keep mortgage rates low. We are
trying to encourage lending, an appropriate balance of lending
between making sure that loans are safe and sound but making
sure creditworthy borrowers have access to credit.
I think one area where I think Congress might want to take
a look, one of the basic problems is that we have such a large
overhang of empty, distressed-sale, foreclosed-upon houses.
That is pulling down prices. That is pulling down appraisals.
As I mentioned earlier, there are about half a million of these
houses in the REO books of the banks and Fannie and Freddie,
plenty more with other types of ownership. And it is hurting
neighborhoods, it is hurting cities. I think that is an area
that is worth looking at. Can we find a way to try and reduce
that overhang or to try to provide incentives for investors to
convert them or something like that? I think that is one of the
main problems that the Fed cannot directly address, but it
could be addressed perhaps by some focused program.
Senator Tester. OK. Do you have any idea of how many--we
talked about excess housing for a while, and that is the
overhang you are talking about, right?
Mr. Bernanke. Well, that is just the REO. There are a
couple million houses that are vacant.
Senator Tester. And typically what do we have normally in a
robust housing market?
Mr. Bernanke. Probably a third of that. I do not know the
exact number.
Senator Tester. OK. Do you have any idea of what percentage
of homes are underwater at this point in time?
Mr. Bernanke. About a quarter or more, 25 to 30 percent.
Senator Tester. A quarter or more?
Mr. Bernanke. Of mortgages. Not homes but of mortgaged
homes.
Senator Tester. OK. All right. Well, thank you very much,
Mr. Chairman. I appreciate it.
Thank you, Senator Reed.
Senator Reed. Senator Schumer, please.
Senator Schumer. Thank you, Mr. Chairman--Mr. Chairman and
Mr. Chairman, for being here, and my colleague Jon Tester.
First, I would like to talk a little bit about deficit
reduction, and Senator Wicker touched on this, but I want to
clarify. Leader McConnell, as you know, has proposed a plan
that would allow for the debt ceiling to be lifted but without
accomplishing any debt reduction. Many of us have conflicted
feelings about this approach because, on the one hand, it would
ensure we do not default, but on the other, it does not make
any headway in reducing our debt, which sooner or later will
cause problems. I like to say we are blindfolded man heading
toward a cliff. If we keep walking in that direction, we will
fall off. Some people think the cliff is 5 yards away, and some
people think it is 50 or 100 yards away. But we are headed that
way.
Anyway, we have to make--the McConnell plan says, OK, renew
the ceiling, no progress on debt.
Which do you think would be more reassuring to investors
and the markets: just raising the debt ceiling or raising the
debt ceiling and achieving some debt reduction at the same
time?
Mr. Bernanke. Well, as I said to Senator Wicker, there are
two prongs to this: one is to avoid the problems associated
with not raising the debt ceiling, but the other is to make
meaningful reductions in the long-term deficit.
Senator Schumer. It would be better to do both than just
one.
Mr. Bernanke. We certainly should. That is certainly the
best outcome.
Senator Schumer. OK, and that is the outcome some of us are
working toward right now, so I appreciate that, because to do
one without the other does not make much sense.
This is about prioritizing interest payments. Many of our
Republican colleagues here in the Senate today, Mr. Toomey on
the Committee, they seem to feel that we can avoid default by
prioritizing interest payments on the debt, pay back just the
debt we owe but not all the other obligations, whether it is
paying our troops or paying the FAA, the guys in the towers so
our airplanes can go, our food inspectors, our Border Patrol,
our FBI.
But if we do not raise the debt ceiling after August 2nd,
that would require us to stop paying almost half of our other
bills, even if you paid back the debt. Isn't that just default
by another name? And, in fact, wouldn't the credit rating
agencies likely downgrade our credit rating anyway if we miss
payments on our other obligations?
Mr. Bernanke. I think the downgrade is possible. I do not
know for sure. I do not think they have stated that precisely.
But, yes, I do think this is a direction we do not want to go.
I think that not paying our obligations, whether they be
financial obligations or payments to Social Security recipients
or others, any of those things would involve essentially a
default.
Senator Schumer. So you do not agree with those that--that
in a sense is default, right?
Mr. Bernanke. I want to add that the Treasury has been
pretty clear that they do not think that is either appropriate
and they are concerned about----
Senator Schumer. And, by the way, to boot, wouldn't that
hurt the economy? If we stop----
Mr. Bernanke. Yes, of course.
Senator Schumer.----paying $160, $170 billion worth of
obligations--maybe it is $110 billion, but it is over $100
billion of obligations. Some estimate that it could reduce the
GDP by a significant percent. Is that right?
Mr. Bernanke. Sure. Of course.
Senator Schumer. So it seems to me you are saying--and I am
not going to put words in your mouth--that Senator Toomey is
just way off base here. For a smart guy, I mean, to say we can
pay the obligations and not pay the rest and that is just fine,
wow, I am sort of surprised at it. And I do think, by the way,
in today's Wall Street Journal I think, it stated that Standard
& Poor's said it would likely downgrade U.S. debt if we missed
payments on other obligations, so they agree with you. OK.
Next, short-term extension. Some around here--Leader Cantor
has been pushing this--have advocated shorter-term extensions
of the debt ceiling so we would have to do this every few
months. Now, of course, markets would be relieved that default
is off the table--in other words, better than not doing
anything. But do you agree that eventually the markets would
start to get nervous that we cannot find the political will to
get a meaningful deal together and might start to view us a
little more like Europe? Wouldn't it send a troubling signal to
the markets if Congress attempted to only extend the debt
ceiling a month or two at a time?
Mr. Bernanke. It is important both to raise the debt
ceiling to avoid these kinds of problems we discussed; it is
also important to show that we can make progress on the long-
term deficit.
Senator Schumer. But I am not talking about the long-term
deficit. I am talking about renewal of the debt ceiling by such
a little amount that month after month we would have to come
back and renew it. Isn't it preferable to do it in as large an
amount as possible just from the debt ceiling point of view?
Mr. Bernanke. Well, there are political and tactical issues
here which I do not want to get into, but clearly----
Senator Schumer. I am not asking you that. I am asking
economically.
Mr. Bernanke.----what we want to do is to get as big a deal
as we can to show that we are serious and that we are going to
address the long-term stability----
Senator Schumer. How would you characterize a 1-month
extension of the debt ceiling compared to, say, doing it until
2012?
Mr. Bernanke. Well----
Senator Schumer. Two thousand thirteen, early 2013?
Mr. Bernanke. The risk is that you would lose credibility
in the markets about your willingness to carry through, and so
if you did that, it would be important to send signals somehow
that you have a plan and----
Senator Schumer. Better to do it through 2013 than do it a
month at a time?
Mr. Bernanke. Well, better to do a strong, credible plan,
and the sooner the better.
Senator Schumer. OK. Thank you, Mr. Chairman.
Thank you, Mr. Chairman.
Mr. Bernanke. Thank you.
Senator Reed. Thank you, Senator Schumer.
I just have one question. Who is the largest holder of our
Treasury debt and our agency debt? Is it the Chinese Government
or Chinese institutions?
Mr. Bernanke. Well, the Fed has a lot----
Senator Reed. You have a lot of it.
Mr. Bernanke. The Chinese, I think probably right.
Senator Reed. Right after the Fed would be the Chinese.
Mr. Bernanke. As an individual institution, the central
bank that holds the reserves.
Senator Reed. Of China.
Mr. Bernanke. Of China, yes.
Senator Reed. So, effectively, if we were to be paying our
debt and not paying our Social Security payments, we would be
principally paying the Chinese central bank in lieu of paying
Americans?
Mr. Bernanke. That is right. But if we did not do that we
would suffer financial consequences.
Senator Reed. I completely concur, and I think the solution
is to appropriately raise the debt ceiling, deal with the
fiscal issues of the deficit that we face, and we are trying to
do that. But just ironically, you know, when you do this sort
of prioritization, the irony is the priority is to the Chinese
central bank, and lower on the pecking order would practically
be seniors and Social Security recipients and maybe even
American military personnel. I think that is the reality, isn't
it?
Mr. Bernanke. Well, again, if prioritization were even
feasible----
Senator Reed. Were even feasible. Your point is you do not
believe it is even feasible.
Well, Mr. Chairman, thank you again not only for your
testimony today but your service to the Nation in very, very
difficult and challenging times.
The hearing record will remain open for 7 days for
additional statements and questions. With that, the hearing is
adjourned. Thank you, Mr. Chairman.
Mr. Bernanke. Thank you, Senator.
[Whereupon, at 12:15 p.m., the hearing was adjourned.]
[Prepared statements and response to written questions
supplied for the record follow:]
PREPARED STATEMENT OF SENATOR JERRY MORAN
Mr. Chairman, I thank you for calling this hearing today and I
thank Chairman Bernanke for joining us to have an important discussion
about the state of our economy.
Mr. Chairman--as you well know, our country is facing a financial
crisis. But in my view, the financial collapse around the corner is the
most expected economic crisis in our lifetime, yet nothing is being
done to stop it. The co-chairs of the President's own Fiscal Commission
agree and have warned that if we fail to take swift and serious action,
the United States faces ``the most predictable economic crisis in its
history.'' They predict such an event could occur in 2 years or less.
The President's solution is to raise revenues to balance the
budget, but does anyone really believe that increased taxes will be
used to pay down the debt or will it just be used for even more
spending? History shows that money raised in Washington, DC, results in
more spending in Washington, DC. If we increase taxes, we reduce the
chance of economic growth and we reduce the chance of more and better
paying jobs.
In Kansas, for example, the President proposes we increase taxes on
those who own a business plane. Airplanes are a pretty important
component of our State's economy, and this proposal would have a
devastating impact upon the Wichita economy, which has already suffered
the loss of thousands of jobs under declining business in this country.
Now is not the time to penalize a U.S. industry that produces the best
quality airplanes in the world. The United States and North America
ship a significant amount of business jets worldwide, more than any
other region in the world. But because of the recession, nearly every
aircraft manufacturer has had to cut jobs, some up to 50 percent of
their workforce. We see this in Kansas day in and day out, and yet the
proposal is to make it more expensive to own an aircraft. This does not
punish the owners of aircraft. It punishes the people who work every
day to make an airplane.
To turn our economy around and put people back to work, Congress
and the Obama administration should be implementing policies that
encourage job creation, not diminish the chances; rein in burdensome
Government regulations; replace our convoluted Tax Code with one that
is fair, simple, and certain; open foreign markets for American
manufactured goods and agricultural products; and develop a
comprehensive energy policy. Yet none of these things are being done.
The debate over Government spending is often seen as a
philosophical or academic debate that always goes on in Washington, DC.
And I am aware of the heated rhetoric that has been exchanged between
both political parties the last few weeks, but the reality is this time
it is different, and our failure to act will have dramatic consequences
on the daily lives of Americans.
Officials from the Obama administration warn that the failure of
Congress to raise the legal debt limit would risk default. But at least
an equal economic threat confronts our country: the consequences of
allowing our country's pattern of spending and borrowing to continue
without a serious plan to reduce that debt. We are not immune from the
laws of economics that face every country, and if we fail to get our
financial house in order, our creditors will decide we are no longer
creditworthy, and we will face the same consequences that other
countries are suffering that followed this path.
Our Government is not on the verge of a financial meltdown because
Republicans will not vote to raise the debt ceiling. We are at the
point of financial catastrophe because Republicans and Democrats have
spent money we do not have for way too long. We must now seize this
opportunity to force elected officials to do something they otherwise
would not do: curb spending, balance the budget, and put in place
policies that allow business, industry, and agriculture to invest in
plants and equipment and create jobs.
If we fail to act responsibly, if we fail to act as we should, if
we let this issue pass one more time for somebody else to solve because
it is so difficult, we will reduce the opportunities the next
generation of Americans have to pursue the American dream. I look
forward to having a conversation with Chairman Bernanke about these
topics and thank him for his appearance here today.
______
PREPARED STATEMENT OF BEN S. BERNANKE
Chairman, Board of Governors of the Federal Reserve System
July 14, 2011
Chairman Johnson, Ranking Member Shelby, and other Members of the
Committee, I am pleased to present the Federal Reserve's semiannual
Monetary Policy Report to the Congress. I will begin with a discussion
of current economic conditions and the outlook and then turn to
monetary policy.
The Economic Outlook
The U.S. economy has continued to recover, but the pace of the
expansion so far this year has been modest. After increasing at an
annual rate of 2 \3/4\ percent in the second half of 2010, real gross
domestic product (GDP) rose at about a 2 percent rate in the first
quarter of this year, and incoming data suggest that the pace of
recovery remained soft in the spring. At the same time, the
unemployment rate, which had appeared to be on a downward trajectory at
the turn of the year, has moved back above 9 percent.
In part, the recent weaker-than-expected economic performance
appears to have been the result of several factors that are likely to
be temporary. Notably, the run-up in prices of energy, especially
gasoline, and food has reduced consumer purchasing power. In addition,
the supply chain disruptions that occurred following the earthquake in
Japan caused U.S. motor vehicle producers to sharply curtail assemblies
and limited the availability of some models. Looking forward, however,
the apparent stabilization in the prices of oil and other commodities
should ease the pressure on household budgets, and vehicle
manufacturers report that they are making significant progress in
overcoming the parts shortages and expect to increase production
substantially this summer.
In light of these developments, the most recent projections by
members of the Federal Reserve Board and presidents of the Federal
Reserve Banks, prepared in conjunction with the Federal Open Market
Committee (FOMC) meeting in late June, reflected their assessment that
the pace of the economic recovery will pick up in coming quarters.
Specifically, participants' projections for the increase in real GDP
have a central tendency of 2.7 to 2.9 percent for 2011, inclusive of
the weak first half, and 3.3 to 3.7 percent in 2012--projections that,
if realized, would constitute a notably better performance than we have
seen so far this year.\1\
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\1\ Note that these projections do not incorporate the most recent
economic news, including last Friday's labor market report.
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FOMC participants continued to see the economic recovery
strengthening over the medium term, with the central tendency of their
projections for the increase in real GDP picking up to 3.5 to 4.2
percent in 2013. At the same time, the central tendencies of the
projections of real GDP growth in 2011 and 2012 were marked down nearly
\1/2\ percentage point compared with those reported in April,
suggesting that FOMC participants saw at least some part of the first-
half slowdown as persisting for a while. Among the headwinds facing the
economy are the slow growth in consumer spending, even after accounting
for the effects of higher food and energy prices; the continuing
depressed condition of the housing sector; still-limited access to
credit for some households and small businesses; and fiscal tightening
at all levels of Government. Consistent with projected growth in real
output modestly above its trend rate, FOMC participants expected that,
over time, the jobless rate will decline--albeit only slowly--toward
its longer-term normal level. The central tendencies of participants'
forecasts for the unemployment rate were 8.6 to 8.9 percent for the
fourth quarter of this year, 7.8 to 8.2 percent at the end of 2012, and
7.0 to 7.5 percent at the end of 2013.
The most recent data attest to the continuing weakness of the labor
market: The unemployment rate increased to 9.2 percent in June, and
gains in nonfarm payroll employment were below expectations for a
second month. To date, of the more than 8 \1/2\ million jobs lost in
the recession, 1 \3/4\ million have been regained. Of those employed,
about 6 percent--8.6 million workers--report that they would like to be
working full time but can only obtain part-time work. Importantly,
nearly half of those currently unemployed have been out of work for
more than 6 months, by far the highest ratio in the post-World War II
period. Long-term unemployment imposes severe economic hardships on the
unemployed and their families, and, by leading to an erosion of skills
of those without work, it both impairs their lifetime employment
prospects and reduces the productive potential of our economy as a
whole.
Much of the slowdown in aggregate demand this year has been
centered in the household sector, and the ability and willingness of
consumers to spend will be an important determinant of the pace of the
recovery in coming quarters. Real disposable personal income over the
first 5 months of 2011 was boosted by the reduction in payroll taxes,
but those gains were largely offset by higher prices for gasoline and
other commodities. Households report that they have little confidence
in the durability of the recovery and about their own income prospects.
Moreover, the ongoing weakness in home values is holding down household
wealth and weighing on consumer sentiment. On the positive side,
household debt burdens are declining, delinquency rates on credit card
and auto loans are down significantly, and the number of homeowners
missing a mortgage payment for the first time is decreasing. The
anticipated pickups in economic activity and job creation, together
with the expected easing of price pressures, should bolster real
household income, confidence, and spending in the medium run.
Residential construction activity remains at an extremely low
level. The demand for homes has been depressed by many of the same
factors that have held down consumer spending more generally, including
the slowness of the recovery in jobs and income as well as poor
consumer sentiment. Mortgage interest rates are near record lows, but
access to mortgage credit continues to be constrained. Also, many
potential homebuyers remain concerned about buying into a falling
market, as weak demand for homes, the substantial backlog of vacant
properties for sale, and the high proportion of distressed sales are
keeping downward pressure on house prices.
Two bright spots in the recovery have been exports and business
investment in equipment and software. Demand for U.S.-made capital
goods from both domestic and foreign firms has supported manufacturing
production throughout the recovery thus far. Both equipment and
software outlays and exports increased solidly in the first quarter,
and the data on new orders received by U.S. producers suggest that the
trend continued in recent months. Corporate profits have been strong,
and larger nonfinancial corporations with access to capital markets
have been able to refinance existing debt and lock in funding at lower
yields. Borrowing conditions for businesses generally have continued to
ease, although, as mentioned, the availability of credit appears to
remain relatively limited for some small firms.
Inflation has picked up so far this year. The price index for
personal consumption expenditures (PCE) rose at an annual rate of more
than 4 percent over the first 5 months of 2011, and 2 \1/2\ percent on
a 12-month basis. Much of the acceleration was the result of higher
prices for oil and other commodities and for imported goods. In
addition, prices of motor vehicles increased sharply when supplies of
new models were curtailed by parts shortages associated with the
earthquake in Japan. Most of the recent rise in inflation appears
likely to be transitory, and FOMC participants expected inflation to
subside in coming quarters to rates at or below the level of 2 percent
or a bit less that participants view as consistent with our dual
mandate of maximum employment and price stability. The central tendency
of participants' forecasts for the rate of increase in the PCE price
index was 2.3 to 2.5 percent for 2011 as a whole, which implies a
significant slowing of inflation in the second half of the year. In
2012 and 2013, the central tendency of the inflation forecasts was 1.5
to 2.0 percent. Reasons to expect inflation to moderate include the
apparent stabilization in the prices of oil and other commodities,
which is already showing through to retail gasoline and food prices;
the still-substantial slack in U.S. labor and product markets, which
has made it difficult for workers to obtain wage gains and for firms to
pass through their higher costs; and the stability of longer-term
inflation expectations, as measured by surveys of households, the
forecasts of professional private-sector economists, and financial
market indicators.
Monetary Policy
FOMC members' judgments that the pace of the economic recovery over
coming quarters will likely remain moderate, that the unemployment rate
will consequently decline only gradually, and that inflation will
subside are the basis for the Committee's decision to maintain a highly
accommodative monetary policy. As you know, that policy currently
consists of two parts. First, the target range for the Federal funds
rate remains at 0 to \1/4\ percent and, as indicated in the statement
released after the June meeting, the Committee expects that economic
conditions are likely to warrant exceptionally low levels of the
Federal funds rate for an extended period.
The second component of monetary policy has been to increase the
Federal Reserve's holdings of longer-term securities, an approach
undertaken because the target for the Federal funds rate could not be
lowered meaningfully further. The Federal Reserve's acquisition of
longer-term Treasury securities boosted the prices of such securities
and caused longer-term Treasury yields to be lower than they would have
been otherwise. In addition, by removing substantial quantities of
longer-term Treasury securities from the market, the Fed's purchases
induced private investors to acquire other assets that serve as
substitutes for Treasury securities in the financial marketplace, such
as corporate bonds and mortgage-backed securities. By this means, the
Fed's asset purchase program--like more conventional monetary policy--
has served to reduce the yields and increase the prices of those other
assets as well. The net result of these actions is lower borrowing
costs and easier financial conditions throughout the economy.\2\ We
know from many decades of experience with monetary policy that, when
the economy is operating below its potential, easier financial
conditions tend to promote more rapid economic growth. Estimates based
on a number of recent studies as well as Federal Reserve analyses
suggest that, all else being equal, the second round of asset purchases
probably lowered longer-term interest rates approximately 10 to 30
basis points.\3\ Our analysis further indicates that a reduction in
longer-term interest rates of this magnitude would be roughly
equivalent in terms of its effect on the economy to a 40 to 120 basis
point reduction in the Federal funds rate.
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\2\ The Federal Reserve's recently completed securities purchase
program has changed the average maturity of Treasury securities held by
the public only modestly, suggesting that such an effect likely did not
contribute substantially to the reduction in Treasury yields. Rather,
the more important channel of effect was the removal of Treasury
securities from the market, which reduced Treasury yields generally
while inducing private investors to hold alternative assets (the
portfolio reallocation effect). The substitution into alternative
assets raised their prices and lowered their yields, easing overall
financial conditions.
\3\ Studies that have provided estimates of the effects of large-
scale asset purchases, holding constant other factors, include James D.
Hamilton and Jing (Cynthia) Wu (2011), ``The Effectiveness of
Alternative Monetary Policy Tools in a Zero Lower Bound Environment,''
NBER Working Paper Series No. 16956 (Cambridge, Mass: National Bureau
of Economic Research, April), and Journal of Money, Credit and Banking
(forthcoming); Arvind Krishnamurthy and Annette Vissing-Jorgensen
(2011), ``The Effects of Quantitative Easing on Interest Rates,''
working paper (Evanston, Ill.: Kellogg School of Management,
Northwestern University, June); Stefania D'Amico and Thomas B. King
(2010), ``Flow and Stock Effects of Large-Scale Treasury Purchases,''
Finance and Economics Discussion Series 2010-52 (Washington: Board of
Governors of the Federal Reserve System, September); Joseph Gagnon,
Matthew Raskin, Julie Remache, and Brian Sack (2011), ``Large-Scale
Asset Purchases by the Federal Reserve: Did They Work?'' Federal
Reserve Bank of New York, Economic Policy Review, vol 17 (May), pp. 41-
59; and Eric T. Swanson (2011), ``Let's Twist Again: A High-Frequency
Event-Study Analysis of Operation Twist and Its Implications for QE2,''
Working Paper Series 2011-08 (San Francisco: Federal Reserve Bank of
San Francisco, February), and Brookings Papers on Economic Activity
(forthcoming).
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In June, we completed the planned purchases of $600 billion in
longer-term Treasury securities that the Committee initiated in
November, while continuing to reinvest the proceeds of maturing or
redeemed longer-term securities in Treasuries. Although we are no
longer expanding our securities holdings, the evidence suggests that
the degree of accommodation delivered by the Federal Reserve's
securities purchase program is determined primarily by the quantity and
mix of securities that the Federal Reserve holds rather than by the
current pace of new purchases. Thus, even with the end of net new
purchases, maintaining our holdings of these securities should continue
to put downward pressure on market interest rates and foster more
accommodative financial conditions than would otherwise be the case. It
is worth emphasizing that our program involved purchases of securities,
not Government spending, and, as I will discuss later, when the
macroeconomic circumstances call for it, we will unwind those
purchases. In the meantime, interest on those securities is remitted to
the U.S. Treasury.
When we began this program, we certainly did not expect it to be a
panacea for the country's economic problems. However, as the expansion
weakened last summer, developments with respect to both components of
our dual mandate implied that additional monetary accommodation was
needed. In that context, we believed that the program would both help
reduce the risk of deflation that had emerged and provide a needed
boost to faltering economic activity and job creation. The experience
to date with the round of securities purchases that just ended suggests
that the program had the intended effects of reducing the risk of
deflation and shoring up economic activity. In the months following the
August announcement of our policy of reinvesting maturing and redeemed
securities and our signal that we were considering more purchases,
inflation compensation as measured in the market for inflation-indexed
securities rose from low to more normal levels, suggesting that the
perceived risks of deflation had receded markedly. This was a
significant achievement, as we know from the Japanese experience that
protracted deflation can be quite costly in terms of weaker economic
growth.
With respect to employment, our expectations were relatively
modest; estimates made in the autumn suggested that the additional
purchases could boost employment by about 700,000 jobs over 2 years, or
about 30,000 extra jobs per month.\4\ Even including the disappointing
readings for May and June, which reflected in part the temporary
factors discussed earlier, private payroll gains have averaged 160,000
per month in the first half of 2011, compared with average increases of
only about 80,000 private jobs per month from May to August 2010. Not
all of the step-up in hiring was necessarily the result of the asset
purchase program, but the comparison is consistent with our
expectations for employment gains. Of course, we will be monitoring
developments in the labor market closely.
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\4\ See Hess Chung, Jean-Philippe Laforte, David Reifschneider, and
John C. Williams (2011), ``Have We Underestimated the Likelihood and
Severity of Zero Lower Bound Events?'' Working Paper Series 2011-01
(San Francisco: Federal Reserve Bank of San Francisco, January).
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Once the temporary shocks that have been holding down economic
activity pass, we expect to again see the effects of policy
accommodation reflected in stronger economic activity and job creation.
However, given the range of uncertainties about the strength of the
recovery and prospects for inflation over the medium term, the Federal
Reserve remains prepared to respond should economic developments
indicate that an adjustment in the stance of monetary policy would be
appropriate.
On the one hand, the possibility remains that the recent economic
weakness may prove more persistent than expected and that deflationary
risks might reemerge, implying a need for additional policy support.
Even with the Federal funds rate close to zero, we have a number of
ways in which we could act to ease financial conditions further. One
option would be to provide more explicit guidance about the period over
which the Federal funds rate and the balance sheet would remain at
their current levels. Another approach would be to initiate more
securities purchases or to increase the average maturity of our
holdings. The Federal Reserve could also reduce the 25 basis point rate
of interest it pays to banks on their reserves, thereby putting
downward pressure on short-term rates more generally. Of course, our
experience with these policies remains relatively limited, and
employing them would entail potential risks and costs. However, prudent
planning requires that we evaluate the efficacy of these and other
potential alternatives for deploying additional stimulus if conditions
warrant.
On the other hand, the economy could evolve in a way that would
warrant a move toward less-accommodative policy. Accordingly, the
Committee has been giving careful consideration to the elements of its
exit strategy, and, as reported in the minutes of the June FOMC
meeting, it has reached a broad consensus about the sequence of steps
that it expects to follow when the normalization of policy becomes
appropriate. In brief, when economic conditions warrant, the Committee
would begin the normalization process by ceasing the reinvestment of
principal payments on its securities, thereby allowing the Federal
Reserve's balance sheet to begin shrinking. At the same time or
sometime thereafter, the Committee would modify the forward guidance in
its statement. Subsequent steps would include the initiation of
temporary reserve-draining operations and, when conditions warrant,
increases in the Federal funds rate target. From that point on,
changing the level or range of the Federal funds rate target would be
our primary means of adjusting the stance of monetary policy in
response to economic developments.
Sometime after the first increase in the Federal funds rate target,
the Committee expects to initiate sales of agency securities from its
portfolio, with the timing and pace of sales clearly communicated to
the public in advance. Once sales begin, the pace of sales is
anticipated to be relatively gradual and steady, but it could be
adjusted up or down in response to material changes in the economic
outlook or financial conditions. Over time, the securities portfolio
and the associated quantity of bank reserves are expected to be reduced
to the minimum levels consistent with the efficient implementation of
monetary policy. Of course, conditions can change, and in choosing the
time to begin policy normalization as well as the pace of that process,
should that be the next direction for policy, we would carefully
consider both parts of our dual mandate.
Thank you. I would be pleased to take your questions.
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY FROM BEN S.
BERNANKE
Q.1. Chairman Bernanke, in prior testimony before this
Committee, you stated that the Fed chose $600 billion as the
appropriate amount for QE2 because that amount would roughly
correspond to a 75 basis point cut in the policy rate in terms
of its broad impact.
Did QE2 work as intended? Did it have the broad
impact of a 75 basis point cut in the policy rate?
A.1. As the expansion weakened in 2010, developments with
respect to both components of our dual mandate implied that
additional monetary accommodation was needed. The Federal
Reserve's second asset purchase program--like more conventional
monetary policy--was intended to reduce interest rates and
boost the prices of a broad range of financial assets, thereby
supporting spending and economic activity. A wide range of
market indicators supports the view that the program had the
desired effects. For example, between August, 2010--when we
announced our policy of reinvesting principal payments on
agency debt and agency MBS and indicated that we were
considering more securities purchases--and late 2010, equity
prices increased significantly, volatility in the equity market
declined, corporate bond spreads narrowed, and inflation
compensation as measured in the market for inflation-indexed
securities rose to historically more normal levels. These
market responses were similar to those that occurred in the
months following our March 2009 announcement of increased asset
purchases.
As I noted in my testimony, we did not expect so-called QE2
to be a panacea for the country's economic problems. But, we
believed that the program would both help reduce the risk of
deflation that had emerged and provide a needed boost to
faltering economic activity and job creation. In the event, the
evidence suggests that the program had its intended effect in
shoring up economic activity and particularly in reducing the
risk of deflation, which as we know from the Japanese
experience can be quite costly in terms of weaker economic
growth.
Q.2. Chairman Bernanke, according to your testimony, the
economic outlook remains uncertain.
What specific metrics do you use to determine how
the economy is doing at any point in time?
A.2. In assessing current and prospective developments in the
macroeconomy, the Federal Reserve monitors a wide variety of
information. For example, we analyze closely data on
production, spending, labor market conditions, prices and
financial markets. We also look at survey-based indicators of
household and business attitudes and spending intentions. In
addition, the Federal Reserve Banks collect anecdotal
information from business contacts in their Districts regarding
current economic conditions, which we publish in the Beige Book
eight times per year. Participants in the meetings of the
Federal Open Market Committee incorporate all of this input
into the formulation of the economic projections that they
prepare four times per year.
Q.3.a. Chairman Bernanke, last month, the Obama administration
announced that it would release 30 million barrels of oil from
the Strategic Petroleum Reserve to ``offset the disruption in
the oil supply caused by unrest in the Middle East.'' When you
were an academic economist, you studied the recessionary
effects of oil price shocks and the Fed's responses to those
shocks.
Has the recent turmoil in the Middle East and the
resulting increase in oil prices already affected our
economic recovery?
A.3.a. Oil prices jumped significantly as a result of the loss
of oil production in a number of North African and Middle
Eastern countries earlier this year, with the most substantial
supply disruptions happening in Libya. The higher energy prices
damped consumer purchasing power and spending during the first
half of the year and likely contributed to some of the weakness
in economic activity in economy that we have observed.
Q.3.b. How will it affect our economy in the coming months?
A.3.b. Since their peak in early April, oil prices have
retraced some of their recent run up. If the lower prices are
maintained, these negative influences on economic activity
should prove to be transitory.
Q.3.c. Has the Obama administration's surprise announcement
resulted in any meaningful positive effects in the oil markets?
Has it had any detrimental effects?
A.3.c. On June 23, the International Energy Agency (IEA)
announced a release of 60 million barrels of oil from strategic
stocks in light of the significant disruption to Libyan crude
supplies and the impending seasonal rise in oil demand. Oil
from the United States' Strategic Petroleum Reserve (SPR)
accounted for about half of the total release. Although the IEA
announcement prompted an immediate decline in oil prices,
parsing out the independent influence of the SPR release on oil
prices is extremely difficult given the myriad factors that
move oil prices. The IEA's announcement may have provided some
certainty regarding near-term oil availability and, therefore,
may have been helpful in reducing oil price volatility in the
short run. In the longer run, however, only increased
production or reduced demand will keep oil prices contained.
Q.3.d. What type of Fed response should we expect?
A.3.d. The Federal Reserve does not respond directly to
movements in oil prices nor to the price of any other
individual items. Rather, consistent with its statutory
mandate, the Federal Reserve seeks to foster maximum employment
and overall price stability. Accordingly, if movements in oil
prices were to have sustained adverse effects on the
macroeconomy--for example, reducing aggregate production and
employment for a prolonged period or causing inflation
expectations to become unanchored--those adverse macroeconomic
developments would factor in the Federal Reserve's overall
policy analysis. As of now, it does not appear that the
increase in oil prices during the latter part of 2010 and the
first part of 2011 has had sustained adverse macroeconomic
effects.
Q.4. In an article earlier this year, Dr. Martin Feldstein,
former President of the National Bureau of Economic Research,
expressed his concern that QE2 could result in asset-price
bubbles that may come to an end before the year is over. In
recent speeches, you and Federal Reserve Bank of Kansas City
President Thomas Hoenig both have mentioned potential bubbles
in agricultural land prices.
What data do you examine to evaluate the risk of
asset bubbles from QE2?
In addition to agricultural land prices, do you see
any evidence of asset bubbles forming in other markets,
such as the stock market or the bond market?
A.4. The Federal Reserve, working in concert with the Financial
Stability Oversight Council (FSOC), reviews a very wide range
of data in assessing financial conditions and evidence of asset
price imbalances. The FSOC annual report provides a very useful
discussion of the types of data employed in financial stability
analysis (see http:// www.treasury.gov/initiatives/fsoc/Pages/
annual-
report.aspx).
As discussed in the FSOC annual report, there are no clear
signs at present of the types of financial imbalances observed
prior to the financial crisis. The management of credit and
liquidity risk in most sectors appears conservative, and market
prices do not provide clear indications of a departure of asset
prices from fundamentals.
Q.5. Federal Reserve Bank of Philadelphia President Charles
Plosser has proposed a plan to shrink the Fed balance sheet
while raising interest rates, based on a simple exit rule
proposed by Professor John Taylor. Under Taylor's plan, the Fed
would reduce reserve balances by $100 billion for each 25 basis
point increase in the Fed funds rate.
Do you agree that this would be a good strategy?
A.5. As noted in the minutes of the June 2011 FOMC meeting, all
but one of the FOMC participants agreed on key elements of an
exit strategy that will adjust the level of short-term interest
rates and normalize the size and composition of the balance
sheet over time. (See the discussion on page 3 of the FOMC
minutes at http://www.federalreserve.gov/monetarypolicy/files/
fomcminutes
20110622.pdf). This strategy would not involve the type of
tight linkage between increases in the Federal funds rate and
incremental declines in reserve balances described by President
Plosser. However, it is quite likely that reserve balances
would gradually decline over the same period in which short-
term interest rates are rising.
Q.6. Chairman Bernanke, I want to follow up on the FOMC's
discussion, detailed in the minutes for the June meeting, of
the principles that will ``guide the strategy'' of shrinking
the Fed's balance sheet.
Do you believe that the Fed's exit plan should be
transparent to the public?
If so, when can we expect the Fed to announce its
formal plan for shrinking its balance sheet?
A.6. The Federal Reserve remains committed to transparency as a
fundamental principle that supports both the effective
implementation of monetary policy and appropriate
accountability of the central bank to the Congress and the U.S.
taxpayer. The FOMC provided a considerable level of detail
regarding its plans for shrinking its balance sheet over time
in the minutes of the June 2011 FOMC meeting; more details on
the precise timing and operational implementation of these
steps will be communicated well in advance of any policy
actions. Based on current information, it appears that more
detailed information on the exit strategy will not be necessary
for some time. In its January 2012, FOMC statement, the FOMC
noted that it currently anticipates that economic conditions--
including low rates of resource utilization and a subdued
outlook for inflation over the medium run--are likely to
warrant exceptionally low levels for the Federal funds rate at
least through late 2014.
Q.7. Federal Reserve Bank of Philadelphia President Charles
Plosser has said that the excess bank reserves parked at the
Fed are ``fuel for inflation.''
Are you concerned that excess reserves will flow
out too quickly and create inflationary pressures?
What specific metrics are you using to determine
whether the Fed should start reining in excess reserves
by raising interest rates?
A.7. The FOMC has the tools it needs to remove policy
accommodation at the appropriate time. As noted in the exit
strategy discussion in the June 2011 FOMC minutes, even with an
expanded balance sheet and elevated levels of excess reserves,
the Federal Reserve can put upward pressure on interest rates
by raising the interest rate paid on reserve balances.
Moreover, the Federal Reserve has developed new reserve
draining tools such as reverse RPs and term deposits that can
be used to reduce the quantity of excess reserves. Finally, the
Federal Reserve can sell securities to remove policy
accommodation and lower the quantity of reserves.
The Federal Reserve conducts monetary policy to foster its
statutory mandate to promote maximum employment and price
stability. The Federal Open Market Committee carefully monitors
a very wide array of economic indicators in assessing the
outlook for inflation including variables such as various
measures of resource slack, cost pressures, and inflation
expectations. In addition, the Committee regularly monitors the
level of excess reserves, money growth, and bank lending as
part of the policy process. In its January, 2012 statement, the
Committee noted that it anticipates inflation will run at or
below those consistent with the Committee's dual mandate over
coming quarters.
Q.8. The Federal Reserve recently lost a case against Bloomberg
in which it opposed disclosing to the public the names of banks
that had borrowed from the discount window. This case is an
important precedent in improving the Fed's transparency.
Who made the initial decision to not release the
information? When Bloomberg decided to litigate, who
made the decision to fight the release in court?
How will the Bloomberg case impact the Fed's
disclosure policies going forward with respect to its
bank regulation activities? In other words, will you
continue to oppose the release of this type of
information notwithstanding the ruling in Bloomberg?
A.8. It had been the Federal Reserve's longstanding practice
since 1914 not to publicly release the names, loan amounts,
dates or collateral pledged for individual discount window
loans. This practice, consistent with the practices of major
central banks around the world, resulted from concern about the
stigma that can result from public knowledge that a financial
institution has borrowed from the Federal Reserve, which acts
as the lender of last resort to banks that are unable to access
ordinary sources of liquidity on a short-term basis. Although a
bank may borrow from the discount window for reasons other than
financial difficulties, disclosure of just the fact that a bank
has borrowed can lead to runs on the bank or other serious
consequences that can harm individual banks or our Nation's
economy.
The decision to defend the Board's position in litigation
initiated by Bloomberg was made after consultation between the
Board and its Legal Division, and the Board's litigation
position was developed by the Board's Legal Division. The
decision to litigate was based on well-established FOIA
precedent holding that privileged or confidential commercial or
financial information obtained from a person, the disclosure of
which would likely result in competitive injury--such as the
discount window lending information at issue--is exempt from
disclosure under FOIA Exemption 4. Following the Supreme
Court's denial of the petition for certiorari filed in the
Bloomberg case, the Board fully complied with the Second
Circuit's decision in Bloomberg.
Section 1103(b) of the Dodd-Frank Wall Street Reform and
Consumer Protection Act, Pub. L. No. 111-203, 124 Stat. 1376,
provides for the disclosure of the names, loan amounts, and
certain other information about individual discount window
loans made after the date of enactment. This information must
be released 2 years after the loan was made, and is exempt from
disclosure before that period. 124 Stat. 2118-19. Section 11
03(b) also provides for disclosure of borrower information for
lending under emergency facilities that may be authorized in
the future under section 13(3) of the Federal Reserve Act no
later than 1 year after the effective date of the termination
of the credit facility. Id. Separately, as required under
section 1109(c) of Dodd-Frank, on December 1, 2010, the Board
disclosed on its public Web site borrower and related
information concerning emergency credit decisions made prior to
July 21, 2010, under section 13(3). 124 Stat. 2129. This and
much more information can be found at the following link:
http://www.federalreserve.gov/monetarypolicy/
bst_supportspecific.htm.
The Board believes that the time lag provided for in
section 1103(b) between the time a discount window loan is made
and the date of publication of borrower-related information
about that loan will substantially lessen the stigma and
potential for harm to borrowing institutions that could result
from the earlier publication of this information while at the
same time fostering public accountability for the Federal
Reserve's lending practices. The FOIA as written and
interpreted prior to the enactment of Dodd-Frank would not have
allowed this balancing of interests.
Q.9. In a recent editorial in the Wall Street Journal,
University of Chicago Professor John Cochrane points out that
the average maturity of Treasury debt is less than a year.
Should we be concerned that the need to frequently
roll over our debt presents more opportunities for
Treasury investors to take flight over concerns about
the U.S. fiscal condition?
What impact could that have on our debt service
costs?
What impact could that have on the real economy?
A.9. As noted in the Treasury's quarterly refunding documents,
the average maturity of marketable Treasury debt outstanding is
about 5 years--about in the middle of the range observed over
the last 25 years. (See http://www.treasury.gov/resource-
center/data-chart-center/quarterly-refunding/Documents/
TBAC%20Discussion%20
Charts%20Feb%202012.pdf.)
The U.S. Treasury issues large volumes of debt on regular
weekly, monthly and quarterly auction cycles. As was widely
noted in the discussions over the debt ceiling, the inability
to rollover maturing debt would have very serious consequences
for debt servicing costs, the level of interest rates,
financial market functioning, and the real economy. At present,
investor demand for Treasury securities remains strong and
Treasury yields are very low by historical standards. However,
as I have noted on previous occasions, the current fiscal
situation of the United States is not sustainable. The low
level of Treasury yields reflects confidence that Congress and
the Administration will implement in a timely manner changes
necessary to bolster the long-run fiscal position of the United
States.
------
RESPONSE TO WRITTEN QUESTION OF SENATOR REED FROM BEN S.
BERNANKE
Q.1. Extended unemployment insurance benefits provided during
the economic downturn have fostered economic stability by
helping to maintain consumer spending and keeping people in
their homes.
Nationwide, Federal Government outlays for
unemployment assistance were $120 billion in 2009 and
$158 billion in 2010--a marked increase from 2008
levels of $43 billion.\1\
---------------------------------------------------------------------------
\1\ Table 11.3 pgs. 247; FY l2 Historical Tables.
Rhode Islanders have received a total of more than
$850 million in Federally funded UI benefits since the
outset of the temporary program.\2\
---------------------------------------------------------------------------
\2\ Rhode Island Dept. of Labor & Training; Labor Market
Information; http://www.dlt.ri.gov/lmi/uiadmin/2011.htm.
These benefits are set to terminate at the end of this
year.
Considering the Federal Reserve projects the unemployment
rate to be as high as 8.7 percent (with a low of 7.5 percent)
next year, what do you believe will be the consequences to the
economy and the impact felt by individual families if
unemployment insurance benefits are allowed to lapse?
A.1. According to the latest estimates, about 3 \3/4\ million
persons received extended or emergency unemployment
compensation (EUC) in mid-July, of whom 2,000 were Rhode
Islanders. Nationally, EUC benefit payments have averaged about
$4 billion per month so far this year, of which about $20
million per month was received by Rhode Islanders. Were those
benefits to lapse, some current recipients would likely find
jobs. However, given the weak economy and the associated
scarcity of job opportunities, many others would have
difficulty finding employment and would likely suffer a
significant reduction in their incomes. All else equal, I would
expect that the expiration of emergency unemployment
compensation would lower total household income and consumption
in 2012, reducing the rate of economic growth by a small
amount.
Q.2. On Tuesday, July 12, 2011, Bruce Bartlett, a former senior
policy advisor to both Presidents Reagan and H.W. Bush, warned
about the possibility of repeating mistakes of the past. Mr.
Bartlett compared the contraction in Government spending and
investment during 1937-38, which spurred a recession, to our
current situation. Then, as now, the economy was slowly
recovering from a financial crisis. Mr. Bartlett wanted us to
be ``very careful, because it may only take a small misstep on
either the monetary or fiscal side to the balance.''
In 1937, during the Great Depression, the Government made a
significant economic policy error. Federal fiscal policy turned
sharply contractionary, and the Federal deficit was reduced to
about 2.5 percent of GDP. The Fed also tightened monetary
policy. The result was a downturn that extended the Depression.
Do you think that, under current circumstances, a
significant fiscal contraction could recreate the ``Mistake of
1937''? Why or why not?
A.2. The Federal budget swung from a deficit of 4 percent of
GDP in 1936 to balance in 1937. To be sure, if Congress and the
Administration were to balance the budget as rapidly as
occurred in 1937 this would have significant negative
consequences for economic growth and employment in the near
term. In part, this reflects the fact that monetary policy has
less capacity than usual to offset a contractionary fiscal
policy of magnitude of 1937 because interest rates are already
quite low. In this regard, both fiscal and monetary policy face
the challenge of balancing the short run concerns of supporting
the recovery with long run concerns of sustainable fiscal
policy and low inflation. I have spoken about the challenges
facing fiscal policymakers as they try to balance support for
the economy in the near-term with the need to address long-run
fiscal imbalances. Fiscal policy actions over the past 2 years
have bolstered aggregate demand and given some impetus to
economic activity. For example, the 2009 stimulus package and
last year's fiscal policy actions have provided support to the
economy during this period of weakness without significantly
worsening the long-run outlook.\3\ Recent budget actions and
most current proposals to reduce the large Federal deficits
appear to be designed to phase-in the budget restraint over
time, again trying to balance these two objectives.
---------------------------------------------------------------------------
\3\ These actions included the extension of Medicaid and education
grants, the extension of the 2001-3 tax cuts and EUC benefits, and the
enactment of the payroll tax cut.
Q.3. As you know, the Federal Reserve's Flow of Funds report
(first quarter 2011) indicates that nonfinancial businesses are
sitting on $1.9 trillion in ``cash'' defined as total liquid
assets [L. 102 Nonfarm Nonfinancial Corporate Business, Line
41, Total liquid assets].
Can you put this figure into historical perspective? What
is the Federal Reserve doing--consistent with its statutory
mandate to foster maximum employment--to get corporations to
use their cash to make more investments that create jobs? Are
there other good measures of how much cash on hand is held by
corporations?
A.3. The share of cash in the total assets for nonfinancial
corporations is estimated to have remained at about 11 percent
as of 2011 Q1,\4\ a high level by historical standards. Part of
the explanation for these high cash balances may reflect an
upward shift in the precautionary demand for cash, following
the liquidity and credit market disruptions seen during the
past recession. High cash retention may also result from firms
that earn significant profits overseas. These firms may choose
to hold the resulting cash on balance sheets of their foreign
subsidiaries to facilitate future investment overseas or to
minimize corporate tax expenses.
---------------------------------------------------------------------------
\4\ Source: Standard and Poors Compustat.
Q.4. Corporate profits reached an all-time high in the first 3
months of 2011, with companies raking in an annualized $1.727
trillion in pre-tax operating profits.\5\ \6\
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\5\ http://www.bea.gov/national/xls/technote_tax_acts.xls.
\6\ http://www.bea.gov/newreleases/national/gdp/2011/pdf/
gdp1q11_3rd/pdf. [Table 11]
---------------------------------------------------------------------------
Can you explain the disjunction between booming profits and
the need for more robust job creation? How much of this profit
is earned overseas? Why isn't more of it being invested in job-
creating activities?
A.4. In the most recently published National Income and Product
Accounts (NIPAs), total corporate profits increased in the
first quarter of 2011 to $1.876 trillion, an 8.8 percent gain
relative to year-earlier levels. A large fraction of those
profits, about one-third, were earned from operations outside
of the United States.\7\ In fact, in the first quarter,
receipts from foreign operations grew 12 percent from four
quarters earlier, while profits generated from U.S. domestic
operations grew 8 percent. As overseas operations have become a
larger part of the business of U.S. parent companies, a higher
fraction of the parent firms' profits are generated using
foreign, as opposed to domestic, labor. Moreover, firms may be
reluctant to invest in activities that create jobs in the
United States if they are uncertain about the prospects for
growth in U.S. demand, especially if they perceive that
opportunities for sales and profit growth primarily lie in
overseas markets.
---------------------------------------------------------------------------
\7\ Receipts from the rest of the world totaled $612 billion in
2011 Q1.
Q.5. Most States began the new fiscal year on July 1st. Even
though revenues are rising, many States are not in a position
to close their budget gaps. Consequently, States have been
forced to make massive spending cuts, often impacting the most
vulnerable populations.
How has the lapse of Federal funding flowing from the
temporary assistance provided by the Recovery Act affected
States? Will cuts in State spending exacerbate the economic
situation? If current expectations weaken, would further
Federal stimulus in the short term help prevent protracted
stagnation? Why or why not?
A.5. State and local government budgets have been under
considerable stress owing to the combination of a deep
recession and their balanced budget requirements. Some of this
strain has been alleviated by the extraordinary Federal aid
given through the 2009 Recovery Act and the subsequent aid
package enacted last year. Nevertheless, the Bureau of Economic
Analysis estimates the real State and local purchases have been
contracting since early 2008. This decline in State and local
government spending reduced real GDP growth by two-tenths
percent in 2010 and by four-tenths percent so far in 2011.
With the depth of the recession and slowness of the
recovery it is likely that State and local governments are
spending a large fraction of the extra Federal aid, but it is
difficult to determine how much of the recent weakness in State
and local spending reflects the decline this year in Federal
aid from the Recovery Act and how much reflects their reaction
to weak revenues.\8\ In particular, because the size and timing
of the grants has been known from some time, State and local
governments may have tried to smooth through the 2010 bulge in
grants, saving some of the 2010 grants to support spending in
2011. Moreover, in the aggregate data the pickup in State and
local tax revenues over the past year has offset the downshift
in Federal grants. State government revenues remain low
relative to pre-recession trends, though, and layoffs in the
sector have shown no signs of slowing. This suggests that
budgets are still strained and that additional Federal aid
would likely provide some support for State and local spending.
---------------------------------------------------------------------------
\8\ Federal aid to State and local governments from the 2009
Recovery Act totaled $79 billion in 2009, $124 billion in 2010, and $63
billion (at an annual rate) so far in 2011. Some of this decline has
been offset by last year's $25 billion extension of Medicaid and
education stimulus grants.
Q.6. Consumer spending accounts for roughly 70 percent of
overall economic activity. As a result of the recession and the
impact on wealth, personal savings as a percentage of
disposable personal income has increased from its recent low of
0.8 percent in April 2005 to 5.0 percent in May (down from
recent peak of 8.2 percent in May 2009).
How can we spur the type of economic growth we need in
order to create jobs in light of consumers appropriately
decreasing spending and increasing savings in response to a
weak economy?
A.6. You are correct to emphasize the importance of consumer
spending for the economic outlook. The forces weighing on
consumer spending, which include a need by many households to
increase savings in a difficult economic environment, are an
important part of the reason that the FOMC projects only
moderate economic growth and a relatively slow decline in the
unemployment rate during the next couple of years.
Nevertheless, increasing personal saving, and the exercise of
sound judgment in personal financial affairs more generally,
are not inconsistent with a healthy growing economy, and sound
household decisionmaking can lay the foundations for
sustainable economic growth. Looking forward, I do expect
consumer spending to play some role in contributing to an
economic recovery that gradually picks up steam as households
make further progress in strengthening their balance sheets, as
credit availability improves further, and especially as job and
income prospects gradually improve. The Federal Reserve is
committed to doing its part to meet its statutory mandate to
promote maximum employment in the context of price stability.
Q.7. On Wednesday, June 29th, the Federal Reserve announced the
extension of temporary U.S. dollar liquidity swap lines with
several foreign central banks until August 2012. What were the
reasons for this action? What are the strengths and weaknesses
of this policy?
A.7. These lines were extended because we believe they are
helpful in relieving persistent strains in dollar funding
markets abroad, which, as we saw beginning in 2007, can spill
over into U.S. financial markets. Given the level of
integration of global finance and the possibility that further
turbulence in European financial markets would spill over into
the United States, it seemed prudent, as a precautionary
measure, to leave the lines in place for a while longer.
The main policy benefit of the swap lines is to help
contain the spread of pressures in global dollar funding
markets into the United States. In addition, the swap lines
carry minimal risk to the Federal Reserve. The lines convey no
exchange rate risk and negligible counterparty risk because the
Federal Reserve's transactions are only with other foreign
central banks, whose credit standing is of the highest quality.
The credit risks that result from lending the dollars acquired
through the swap lines are borne solely by the foreign central
banks.
Q.8. In April of this year, the Federal Reserve, the OCC, and
the OTS released their Interagency Review of Foreclosure
Policies and Practices, which resulted in the OCC's consent
orders requiring banks to hire independent consultants to do a
foreclosure review of past practices. As part of this review,
these consultants will be reviewing the bank's loss mitigation
activities. That is, whether the banks properly evaluated
families for loan modifications in order to avoid foreclosures
that could have been prevented.
Do you believe that as part of this review, which requires
the consultants to ``1) identify borrowers that have been
financially harmed by deficiencies identified in the
independent review and 2) provide remediation to those
borrowers where appropriate,'' the consultant should review the
file of every borrower who was denied a loan modification?
A.8. For the four mortgage servicers that have entered into
Consent Orders with the Federal Reserve, we are requiring a 100
percent review of all denied loan modifications for loans
serviced by the servicer that were pending foreclosure at any
time from 1/1/2009 until 12/31/2010, as well as where a
foreclosure sale occurred during that time period.
Q.9. Please describe any recent trends in bank's converting
from Federal to State charters, or from State to Federal
charters. For example, a number of smaller financial
institutions in Massachusetts recently became Federal Reserve
members, including Canton Co-operative Bank, Reading Co-
operative Bank, Walpole Co-operative Bank, among others.
Please provide a list of the banks converting their
charters to the Federal Reserve during the past the
last year.
Please describe all factors that contribute to this
trend.
Please describe any incentives or encouragement by
Federal Reserve staff relating to these conversions.
A.9. During the year ended June 30, 2011, 36 banks converted to
State member banks supervised by the Federal Reserve. This
includes eight national banks that were previously supervised
by the Office of the Comptroller of the Currency and 28 State-
chartered banks that were previously supervised by the Federal
Deposit Insurance Corporation. Over the last 5 calendar years
(through December 31, 2010), the average number of banks
converting to State member banks was 24 and the number of
conversions in each year ranged from 19 to 35. This suggests
that the trend has not changed significantly.
A number of factors may affect a bank's decision to change
charters. These include the perceived quality of supervision by
a given agency, an agency's perceived level of knowledge about
local market conditions, the accessibility and responsiveness
of regulators, the amount of examination fees charged by State
versus Federal regulatory agencies, or the perceived benefits
of a national charter for operating a nationwide banking
operation.
The Federal Reserve typically accepts only banks rated 1 or
2 under the interagency CAMELS rating system as State member
banks. New State members also generally must have satisfactory
or better consumer compliance or CRA ratings and present no
major unresolved supervisory issues. In some cases, pre-
membership examinations may be required as described in the
Federal Reserve's SR Letter 11-2/CA Letter 11-2. In addition,
the Federal Reserve complies with the July 1, 2009 interagency
Statement on Regulatory Conversions which, among other things,
emphasizes that the agencies will not entertain regulatory
conversion applications that undermine the supervisory process.
Federal Reserve staff members do not provide incentives to
converting banks, but the Federal Reserve Banks provide
information on the process for applying for membership when
asked and on their Web sites. Also, when approached by banks
about potential membership they explain their approach to
supervising State members, provide information on the support
and guidance that they provide to current State members, and
answer banks' inquiries related to membership.
Q.10. What is the counterparty exposure in the financial sector
on the ``sell side'' to Government paper (U.S. Treasuries,
Fannie Mae, Freddie Mac, etc.) Please include all financial
firms for which you have data, including but not limited to
bank holding companies, hedge funds, and money markets. In
addition, please list the increase to cash collateral that may
required if any of this Government paper defaults, as well the
cash which may be necessary to pay off the contract.
A.10. The first attached table shows Treasury and Agency
holdings of the top 50 bank holding companies as of March 31,
2011. It is based on FRY9-C filings.
The Federal Reserve does not directly regulate hedge funds
or money market funds. The Securities and Exchange Commission
(SEC) may be better positioned to respond to that part of the
request.
The procedures for addressing changes in collateral values,
including due to default of the issuer of the debt serving as
collateral, vary substantially across types of activities and
by counterparties. In a worst case scenario, a USG default
would require the party posting U.S. Treasury debt as
collateral to replace the full amount with cash or other
eligible assets, as specified in the underlying contract(s)
governing each bilateral relationship. The second attached
table shows the fair value of Treasury and Agency securities
posted by OTC derivatives counterparties and held by the top 50
bank holding companies.
Separately, under a credit default swap contract where the
USG is the reference entity, the party having sold default swap
protection will need to pay to the buyer of protection the
notional amount less the recovery rate, under cash settlement.
In the worst case scenario, where there is zero recovery on a
defaulted USG debt obligation, the amount necessary to payoff
the contract would be the notional amount of protection sold.
Data on CDS, including those contracts referencing the USG, is
compiled by the Trade Information Warehouse (TIW) managed by
DTCC. See http://www.dtcc.com/products/derivserv/
data_table_i.php.
Q.11. What is the size of the market for credit default swaps
on United States Government paper? What are the consequences of
low rates on these contracts if the Government defaults on its
obligations? What other current market forces may affect this
market?
A.11. According to the Depository Trust and Clearing
Corporation (DTCC) $29.4 billion in gross notional CDS on U.S.
Treasury debt were outstanding as of July 29, 2011. However, a
significant proportion of this gross value reflects offsetting
trades between counterparties in which, for example, a party's
long position is effectively unwound by entering into an
offsetting short position. Measured on a net notional basis,
$5.6 billion in CDS referencing U.S. Government paper were
outstanding. Whether measured on a gross or a net basis, the
market for CDS on U.S. Government paper is miniscule relative
to the $9.9 trillion in Federal Government debt held by the
public. CDS on U.S. Government paper represents well under 1
percent of the outstanding CDS on single-name reference
entities (both corporates and sovereigns). DTCC reports that
overall $15.8 trillion gross notional and $1.2 trillion net
notional CDS on single name reference entities were outstanding
as of July 29.
CDS spreads reflect market participants' forward-looking
expectations about the likelihood and severity of a reference
entity default as well as participants' risk appetite. To the
extent that market participants revise expectations about the
likelihood or severity of a U.S. sovereign default upward,
spreads on CDS referencing U.S. treasuries could be expected to
rise. Were a default to actually occur, it is likely that no
new contracts referencing U.S. treasuries would be negotiated
until existing contracts were settled. Spreads on all CDS (not
just those referencing U.S. Government paper) also depend on
market participants' overall willingness to bear risk. Both CDS
and bond spreads tend to fall during times when market
participants are more willing to take on risk and rise when
market participants become more risk averse.
Spreads on short-duration CDS referencing U.S. treasuries
increased substantially prior to the passage of the Federal
debt-limit expansion on August 2. The spread on 1-year maturity
CDS on U.S. treasuries reported by Markit Partners hovered
around 10 basis points from January through April but grew to
about 30 basis points in May and peaked at 57 basis points on
July 27. By market close on August 3, the spread had fallen
back to a still somewhat elevated level of 26 basis points.
Q.12. What analysis has been done to evaluate and quantify the
gross credit default exposure of the top 10 banks in the United
States to credit defaults swaps written on European sovereign?
What source data does the Federal Reserve use in such analysis?
A.12. Banking supervisors and analysts at the Board and Reserve
Banks have been monitoring the peripheral European sovereign
CDS exposures of the largest U.S. bank holding companies (BHCs)
for some time. Analyses have tended to focus on the market risk
and counterparty profiles for each BHC. Special analyses--e.g.,
with regards to ``hedge (in)effectiveness'' and its impacts--
are done as events in the region and supervisory assessments
warrant.
With regards to CDS, a variety of data sources are utilized
and cross-checked against each other to ensure that risk
assessments are not reliant on any single source:
1. CDS trade data from DTCC's Trade Information Warehouse
provides useful perspectives on trends, in particular
with gross and net notional positions referencing
different sovereigns and the identities of
counterparties. (Note, counterparty credit risk
exposures cannot be inferred from DTCC CDS data. See #3
below.)
2. Targeted supervisory data requests provide opportunities
to gather additional information (e.g., mark-to-market
information, which the DTCC CDS data lacks) from
different perspectives (e.g., risk systems). Given that
over-the-counter derivatives trading is bilateral, data
provided by one firm can be cross-checked against the
same data provided by a counterparty firm to gauge data
robustness and to flag areas for supervisory followup.
3. Continuous monitoring of firms' top European bank
counterparty credit risk exposures, internal scenario
loss estimates, liquidity/funding conditions and ad hoc
internal risk management analyses provide insight into
BHCs' evolving risk profiles. Although these are not
CDS-specific, the risks from CDS positioning are
reflected, and as such can be cross-checked against
information gleaned from the sources above.
4. LRegulatory reporting data provides another perspective.
Attachment for Question 9
Attachments for Question 10