[Senate Hearing 112-483]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 112-483

 
        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2012

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

                                HEARING

                               before the

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

                      ONE HUNDRED TWELFTH CONGRESS

                             SECOND SESSION

                                   ON

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

                               __________

                             MARCH 1, 2012

                               __________

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


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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

                     Laura Swanson, Policy Director

                   Glen Sears, Senior Policy Advisor

                 Jana Steenholdt, Legislative Assistant

               Andrew J. Olmem, Republican Chief Counsel

              Michael Piwowar, Republican Chief Economist

                       Dawn Ratliff, Chief Clerk

                     Ryker Vermilye, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)


                            C O N T E N T S

                              ----------                              

                        THURSDAY, MARCH 1, 2012

                                                                   Page

Opening statement of Chairman Johnson............................     1
    Prepared statement...........................................    31

Opening statements, comments, or prepared statements of:
    Senator Shelby...............................................     2

                                WITNESS

Ben S. Bernanke, Chairman, Board of Governors of the Federal 
  Reserve System.................................................     4
    Prepared statement...........................................    31
    Responses to written questions of:
        Chairman Johnson.........................................    35
        Senator Menendez.........................................    38
        Senator Hagan............................................    44
        Senator Crapo............................................    46
        Senator Toomey...........................................    47
        Senator Wicker...........................................    50

              Additional Material Supplied for the Record

Monetary Policy Report to the Congress dated February 29, 2012...    52

                                 (iii)


        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2012

                              ----------                              


                        THURSDAY, MARCH 1, 2012

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:04 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.
    Today I welcome Chairman Bernanke back to this Committee to 
deliver the Federal Reserve's semiannual Monetary Report to 
Congress.
    There are reasons to be optimistic about our Nation's 
economic recovery. The U.S. economy has expanded for 10 
straight quarters, and private sector employment has increased 
for 23 straight months. Private employers added 2.1 million 
jobs last year, the most since 2005.
    But there are also reasons to be concerned, such as the 
European debt crisis and the continuing drag of the housing 
market on the broader economy. This Committee has paid close 
attention to these two issues and held numerous hearings. While 
I remain hopeful that we are moving in the right direction, we 
must continue to monitor the situation in Europe closely. On 
housing, there is a variety of policy proposals--some that do 
not require an act of Congress--that should be considered to 
improve the housing market. I want to thank Governor Duke for 
her thoughtful testimony on
    Tuesday before this Committee on the Federal Reserve's 
white paper on options to improve the housing market.
    An additional challenge, the sharp increase in oil prices, 
has the potential to impede the economic recovery. Americans 
continue to grapple with higher fuel costs when they fill up 
their cars or heat their homes. It is important that oil 
markets are closely monitored for signs of manipulation or 
supply disruption, and I look forward to hearing the Fed's 
views on how rising oil prices may affect consumer spending and 
economic growth.
    I appreciate all the Fed has done to ensure continued 
economic recovery. Chairman Bernanke, I look forward to hearing 
more from you on the Fed's recent actions and possible future 
actions to protect our economy.
    Congress also has an important role in making sure the 
economy continues to grow and more Americans continue to find 
the jobs they need. This week, the full Senate continues to 
consider the transportation bill. This bill includes the 
bipartisan effort of this Committee to update our Nation's 
public transit infrastructure and create jobs. I am also 
hopeful that the Senate can find consensus on capital formation 
initiatives, the topic of another hearing next week before this 
Committee, to promote job creation while protecting investors.
    With so many Americans in search of work, it is not too 
late for bipartisan action to create jobs and promote 
sustainable growth. I look forward to your views, Chairman 
Bernanke, on these and other steps Congress can take to improve 
our Nation's economy.
    To preserve time for questions, opening statements will be 
limited to the Chair and Ranking Member. However, I would like 
to remind my colleagues that the record will be open for the 
next 7 days for additional statements and other materials.
    I will now turn to Ranking Member Shelby.

             STATEMENT OF SENATOR RICHARD C. SHELBY

    Senator Shelby. Thank you, Mr. Chairman. Welcome again, Mr. 
Chairman.
    Since the Federal Reserve took unprecedented actions in 
response to the financial crisis, there has been a growing 
recognition that the Fed needs to become more transparent. 
There was a time when central bankers met behind closed doors 
and stubbornly refused to inform the public of their decisions. 
Those days are clearly over.
    The public now rightly demands that policy makers not only 
explain their decisions but also be accountable for their 
actions. This is especially true of the Federal Reserve, which, 
thanks to Dodd-Frank, now exercises even greater authority over 
the American economy and the lives of every American.
    To his credit, Chairman Bernanke has long recognized the 
need to modernize the Fed. In his first confirmation hearing 
before this Committee, he stated that he believed making the 
Fed more transparent would, and I will quote his words, 
``increase democratic accountability, promote constructive 
dialog between policy makers and informed outsiders, and reduce 
uncertainty in financial markets and help anchor the public's 
expectations of long-run inflation.''
    During Chairman Bernanke's last Humphrey-Hawkins 
appearance, I noted that he has taken some important steps to 
improve the transparency of the FOMC, including holding press 
conferences to discuss monetary policy. Since then, the FOMC 
has taken another step to improve transparency by adopting an 
explicit inflation goal of 2 percent. This is a significant 
event in the history of the Federal Reserve.
    As Chairman Bernanke himself has stated, an explicit 
inflation target could reduce the public's uncertainty about 
monetary policy and more effectively anchor inflation 
expectations. Yet it remains uncertain if the Fed's recently 
announced inflation goal will achieve these objectives.
    While the Fed was establishing its inflation goal, it was 
at the same time communicating contradictory signals about his 
commitment to that inflation target. The FOMC minutes reveal 
that Chairman Bernanke indicated that he believed the inflation 
goal would not represent a change in the FOMC's policy. In 
addition, the FOMC has stated that it believes economic 
conditions are ``likely to warrant exceptionally low levels for 
the Federal funds rate at least through late 2014.'' In other 
words, the Fed is signaling to market participants that it 
expects to continue its near zero interest rate policy for at 
least 3 more years.
    I believe that begs the question: Is the FOMC focused on 
targeting low interest rates or its new inflation goal? If the 
inflation goal conflicts with keeping interest rates near zero, 
which target will prevail? In other words, why should market 
participants have confidence that the Fed is actually committed 
to achieving its inflation goal? And if the Fed is not serious 
about achieving its inflation goal, how will the Fed's 
credibility suffer when inflation rises above 2 percent?
    Accordingly, today I hope that Chairman Bernanke can give 
the Committee more insight into how the FOMC's inflation goal 
will work in practice. I would also like to hear whether he 
believes Congress should hold the FOMC accountable for meeting 
its inflation goal. And while the Chairman has taken steps to 
improve the transparency of the FOMC, the transparency of the 
Board of Governors appears to be getting worse.
    A recent Wall Street Journal article noted that the Board 
has held 47--yes, 47--separate votes on financial regulations 
since Dodd-Frank became law, yet they have held only two public 
meetings, Mr. Chairman. The article noted that there has been a 
steady reduction in the number of open meetings by the Board 
since the early 1980s when the Board had more than 30 open 
meetings. As a result, the Fed is making sweeping financial 
regulatory policy decisions behind closed doors. This is 
inconsistent with, Mr. Chairman, your professed goal of making 
the Fed more transparent.
    In another troubling new development, the Fed recently 
decided to enter into the debate on housing policy. On January 
4th, the Fed issued a white paper entitled ``The U.S. Housing 
Market: Current Conditions and Policy Considerations.'' The 
stated goal of the paper was not to provide a blueprint but, 
rather, to outline issues and tradeoffs that policy makers 
might consider. However, subsequent actions by Fed officials 
suggest that the Fed has views about the policies Congress 
should enact.
    Just 2 days after the white paper was released, Fed 
Governor Elizabeth Duke gave a speech in which she advocated 
for specific housing policies and effectively asked the GSE 
conservator to ignore his statutory mandate to conserve and 
preserve assets of the GSEs. That same day, Mr. Chairman, New 
York Fed President William Dudley gave a speech in which he 
argued that it would, in his words, ``make sense'' for Fannie 
and Freddie to ``routinely reduce principal on delinquent 
mortgages using taxpayer dollars.''
    These statements suggest to many that the Fed does, in 
fact, have a blueprint there for housing market policy. That 
blueprint appears to involve using the taxpayer-supported GSEs 
as a piggy bank.
    In weighing in on housing policy, certain Fed Governors 
have begun to take sides in what should be a congressional 
policy debate, I believe. The Fed's independence for monetary 
policy has always been premised on its remaining nonpartisan 
and not advocating for specific legislative measures. The Fed 
has been and should, I believe, continue to be a useful 
resource for information and analysis on the housing market. I 
believe it should not become an active participant in the 
legislative debate over the future of housing finance. I hope 
that the Fed's recent foray into housing policy will not become 
common practice.
    Mr. Chairman, I believe when you say that you believe the 
Fed is most effective when it is nonpartisan, transparent, and 
accountable, I believe that is right. I am interested in 
hearing from you today, Mr. Chairman, on how you intend to 
continue to improve the Fed's performance on all three 
objectives.
    Thank you.
    Chairman Johnson. Thank you, Senator Shelby. Welcome, 
Chairman Bernanke.
    Dr. Ben Bernanke is currently serving his second term as 
Chairman of the Board of Governors of the Federal Reserve 
System. His first term began under President Bush in 2006. Dr. 
Bernanke was Chairman of the Council of Economic Advisers 
during the Bush administration from June 2005 to January 2006. 
Prior to that, Dr. Bernanke served as a member of the Board of 
Governors of the Federal Reserve System from 2002 to 2005.
    Chairman Bernanke, please begin your testimony.

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

    Mr. Bernanke. Thank you. 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 recovery of the U.S. economy continues, but the pace of 
the expansion has been uneven and modest by historical 
standards. After minimal gains in the first half of last year, 
real GDP increased at a 2\1/4\-percent annual rate in the 
second half. The limited information available for 2012 is 
consistent with growth proceeding, in coming quarters, at a 
pace close to or somewhat above the pace that was registered 
during the second half of last year.
    We have seen some positive developments in the labor 
market. Private payroll employment has increased by 165,000 
jobs per month on average since the middle of last year, and 
nearly 260,000 new private sector jobs were added in January. 
The job gains in recent months have been relatively widespread 
across industries. In the public sector, by contrast, layoffs 
by State and local governments have continued. The unemployment 
rate hovered around 9 percent for much of last year but has 
moved down appreciably since September, reaching 8.3 percent in 
January. New claims for unemployment insurance benefits have 
also moderated.
    The decline in the unemployment rate over the past year has 
been somewhat more rapid than might have been expected, given 
that the economy appears to have been growing during that 
timeframe at or below its longer-term trend; continued 
improvement in the job market is likely to require stronger 
growth in final demand and production. Notwithstanding the 
better recent data, the job market remains far from normal: The 
unemployment rate remains elevated, long-term unemployment is 
still near record levels, and the number of persons working 
part time for economic reasons is very high.
    Household spending advanced moderately in the second half 
of last year, boosted by a fourth-quarter surge in motor 
vehicle purchases that was facilitated by an easing of 
constraints on supply related to the earthquake in Japan. 
However, the fundamentals that support spending continue to be 
weak: Real household income and wealth were flat in 2011, and 
access to credit remained restricted for many potential 
borrowers. Consumer sentiment, which dropped sharply last 
summer, has since rebounded but remains relatively low.
    In the housing sector, affordability has increased 
dramatically as a result of the decline in house prices and 
historically low interest rates on conventional mortgages. 
Unfortunately, many potential buyers lack the down payment and 
credit history required to qualify for loans; others are 
reluctant to buy a house now because of concerns about their 
income, employment prospects, and the future path of home 
prices. On the supply side of the market, about 30 percent of 
recent home sales have consisted of foreclosed or distressed 
properties, and home vacancy rates remain high, putting 
downward pressure on house prices. More positive signs include 
a pickup in construction in the multifamily sector and recent 
increases in homebuilder sentiment.
    Manufacturing production has increased 15 percent since the 
trough of the recession and has posted solid gains since the 
middle of last year, supported by the recovery in motor vehicle 
supply chains and ongoing increases in business investment and 
exports. Real business spending for equipment and software rose 
at an annual rate of about 12 percent over the second half of 
2011, a bit faster than in the first half of the year. But real 
export growth, while remaining solid, slowed somewhat over the 
same period as foreign economic activity decelerated, 
particularly in Europe.
    The members of the Board and the presidents of the Federal 
Reserve Banks recently projected that economic activity in 2012 
will expand at or somewhat above the pace registered in the 
second half of last year. Specifically, their projections for 
growth in real GDP this year, provided in conjunction with the 
January meeting of the FOMC, have a central tendency of 2.2 to 
2.7 percent. These forecasts were considerably lower than the 
projections they made last June. A number of factors have 
played a role in this reassessment. First, the annual revisions 
to the national income and product accounts released last 
summer indicated that the recovery had been somewhat slower 
than previously estimated. In addition, fiscal and financial 
strains in Europe have weighed on financial conditions and 
global economic growth, and problems in U.S. housing and 
mortgage markets have continued to hold down not only 
construction and related industries, but also household wealth 
and confidence. Looking beyond 2012, FOMC participants expect 
that economic activity will pick up gradually as these 
headwinds fade, supported by a continuation of the highly 
accommodative stance for monetary policy.
    With output growth in 2012 projected to remain close to its 
longer-run trend, participants did not anticipate further 
substantial declines in the unemployment rate over the course 
of this year. Looking beyond this year, FOMC participants 
expect the unemployment rate to continue to edge down only 
slowly toward levels consistent with the Committee's statutory 
mandate. In light of the somewhat different signals received 
recently from the labor market than from indicators of final 
demand and production, however, it will be especially important 
to evaluate incoming information to assess the underlying pace 
of the economic recovery.
    At our January meeting, participants agreed that strains in 
global financial markets posed significant downside risks to 
the economic outlook. Investors' concerns about fiscal deficits 
and the levels of Government debt in a number of European 
countries have led to substantial increases in sovereign 
borrowing costs, stresses in the European banking system, and 
associated reductions in the availability of credit and 
economic activity in the euro area. To help prevent strains in 
Europe from spilling over to the U.S. economy, the Federal 
Reserve in November agreed to extend and to modify the terms of 
its swap lines with other major central banks, and it continues 
to monitor the European exposures of U.S. financial 
institutions.
    A number of constructive policy actions have been taken of 
late in Europe, including the European Central Bank's program 
to extend 3-year collateralized loans to European financial 
institutions. Most recently, European policy makers agreed on a 
new package of measures for Greece, which combines additional 
official sector loans with a sizable reduction of Greek debt 
held by the private sector. However, critical fiscal and 
financial challenges remain for the euro zone, the resolution 
of which will require concerted action on the part of the 
European authorities. Further steps will also be required to 
boost growth and competitiveness in a number of countries. We 
are in frequent contact with our counterparts in Europe and 
will continue to follow the situation closely.
    As I discussed in my July testimony, inflation picked up 
during the early part of 2011. A surge in the prices of oil and 
other commodities, along with supply disruptions associated 
with the disaster in Japan that put upward pressure on motor 
vehicle prices, pushed overall inflation to an annual rate of 
more than 3 percent over the first half of last year. As we had 
expected, however, these factors proved transitory, and 
inflation moderated to an annual rate of 1\1/2\ percent during 
the second half of the year--close to its average pace in the 
preceding 2 years. In the projections made in January, the 
Committee anticipated that, over coming quarters, inflation 
will run at or below the 2-percent level we judge most 
consistent with our statutory mandate. Specifically, the 
central tendency of participants' forecasts for inflation in 
2012 ranged from 1.4 to 1.8 percent, about unchanged from the 
projections made last June. Looking farther ahead, participants 
expected the subdued level of inflation to persist beyond this 
year. Since these projections were made, gasoline prices have 
moved up, primarily reflecting higher global oil prices--a 
development that is likely to push up inflation temporarily 
while reducing consumers' purchasing power. We will continue to 
monitor energy markets carefully. Longer-term inflation 
expectations, as measured by surveys and financial market 
indicators, appear consistent with the view that inflation will 
remain subdued.
    Against this backdrop of restrained growth, persistent 
downside risks to the outlook for real activity, and moderating 
inflation, the Committee took several steps to provide 
additional monetary accommodation during the second half of 
2011 and early 2012. These steps included changes to the 
forward rate guidance included in the Committee's postmeeting 
statements and adjustments to the Federal Reserve's holdings of 
Treasury and agency securities.
    The target range for the Federal funds rate remains at 0 to 
\1/4\ percent, and the forward guidance language in the FOMC 
policy statement provides an indication of how long the 
Committee expects that target range to be appropriate. In 
August, the Committee clarified the forward guidance language, 
noting that economic conditions--including low rates of 
resource utilization and a subdued outlook for inflation over 
the medium run--were likely to warrant exceptionally low levels 
for the Federal funds rate at least through the middle of 2013. 
By providing a longer time horizon than had previously been 
expected by the public, the statement tended to put downward 
pressure on longer-term interest rates. At the January 2012 
FOMC meeting, the Committee amended the forward guidance 
further, extending the horizon over which it expects economic 
conditions to warrant exceptionally low levels of the Federal 
funds rate to at least through late 2014.
    In addition to the adjustments made to the forward 
guidance, the Committee modified its policies regarding the 
Federal Reserve's holdings of securities. In September, the 
Committee put in place a maturity extension program that 
combines purchases of longer-term Treasury securities with 
sales of shorter-term Treasury securities. The objective of 
this program is to lengthen the average maturity of our 
securities holdings without generating a significant change in 
the size of our balance sheet. Removing longer-term securities 
from the market should put downward pressure on longer-term 
interest rates and help make financial market conditions more 
supportive of economic growth than they otherwise would have 
been. To help support conditions in mortgage markets, the 
Committee also decided at its September meeting to reinvest 
principal received from its holdings of agency debt and agency 
mortgage-backed securities back into agency MBS, rather than 
continuing to reinvest those proceeds in longer-term Treasury 
securities as had been the practice since August 2010. The 
Committee reviews the size and composition of its securities 
holdings regularly and is prepared to adjust those holdings as 
appropriate to promote a stronger economic recovery in the 
context of price stability.
    Before concluding, I would like to say just a few words 
about the statement of longer-run goals and policy strategy 
that the FOMC issued at the conclusion of its January meeting. 
The statement reaffirms our commitment to our statutory 
objectives, given to us by the Congress, of price stability and 
maximum employment. Its purpose is to provide additional 
transparency and increase the effectiveness of monetary policy. 
The statement does not imply a change in how the Committee 
conducts policy.
    Transparency is enhanced by providing greater specificity 
about our objectives. Because the inflation rate over the 
longer run is determined primarily by monetary policy, it is 
feasible and appropriate for the Committee to set a numerical 
goal for that key variable. The FOMC judges that an inflation 
rate of 2 percent, as measured by the annual change in the 
price index for personal consumption expenditures, is most 
consistent over the longer run with its statutory mandate. 
While maximum employment stands on an equal footing with price 
stability as an objective of monetary policy, the maximum level 
of employment in the economy is largely determined by 
nonmonetary factors that affect the structure and dynamics of 
the labor market; it is, therefore, not feasible for any 
central bank to specify a fixed goal for the longer-run level 
of employment. However, the Committee can estimate the level of 
maximum employment and use that estimate to inform policy 
decisions. In our most recent projections in January, for 
example, FOMC participants' estimates of the longer-run, normal 
rate of unemployment had a central tendency of 5.2 to 6.0 
percent. As I noted a moment ago, the level of maximum 
employment in an economy is subject to change; for instance, it 
can be affected by shifts in the structure of the economy and 
by a range of economic policies. If at some stage the Committee 
estimated that the maximum level of employment had increased, 
for example, we would adjust monetary policy accordingly.
    The dual objectives of price stability and maximum 
employment are generally complementary. Indeed, at present, 
with the unemployment rate elevated and the inflation outlook 
subdued, the Committee judges that sustaining a highly 
accommodative stance for monetary policy is consistent with 
promoting both objectives. However, in cases where these 
objectives are not complementary, the Committee follows a 
balanced approach in promoting them, taking into account the 
magnitudes of the deviations of inflation and employment from 
levels judged to be consistent with the dual mandate, as well 
as the potentially different time horizons over which 
employment and inflation are projected to return to such 
levels.
    Thank you. And, of course, I am 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?
    Dr. Bernanke, what are the reasons for the modest pace of 
the current expansion? Is the economy recovering as you would 
expect following a major financial crisis? Or has the Great 
Recession led to any permanent adjustments in either output or 
unemployment levels?
    Mr. Bernanke. Mr. Chairman, normally when an economy 
suffers a severe recession, the recovery is comparatively 
stronger. So a sharp decline tends to have a stronger expansion 
subsequently. However, our economy has been hit by two unusual 
shocks. One is the housing boom and bust, and we know from 
history--and recent Fed research supports this--that housing 
busts tend to take some time to be offset, in particular since 
housing is an important part of the recovery process in most 
expansions.
    Additionally, we have had a severe financial crisis which 
has left still many stresses in the banking system and on the 
financial system, and, again, research, notably by Ken Rogoff 
and Carmen Reinhart, has pointed out that historically 
recoveries following financial crises also tend to be somewhat 
slower than they otherwise would be. So having been hit by both 
of these factors and with housing problems still being 
important, as you noted, and as financial conditions, including 
some of the stresses coming from Europe, still being a drag to 
some extent on economic activity, we have had a slower recovery 
than we otherwise would have anticipated.
    Nevertheless, of course, we have now had growth since mid-
2009 and unemployment has come down, but, of course, the growth 
is not as strong and the improvement in the unemployment rate 
is not as quick as obviously we would like.
    Chairman Johnson. U.S. consumers are deleveraging to reduce 
high debt levels, credit is still tight for U.S. companies and 
households, and fiscal policy has begun to tighten. As we 
consider economic growth in the near and long term, should 
Congress enact drastic spending cuts and balance the budget 
this year? Or would a plan to curb deficits and address 
structural issues over a longer time horizon make more sense 
economically? Also, what sectors of our economy could provide 
sustainable growth over the long term?
    Mr. Bernanke. Well, Mr. Chairman, first of all, as Senator 
Shelby correctly pointed out, the Federal Reserve does not make 
recommendations on specific fiscal policy decisions. But in the 
broad context, let me make two points.
    The first is that, as I have said on a number of occasions, 
including in front of this Committee, the United States is on 
an unsustainable fiscal path looking out over the next couple 
of decades. If we continue along that path, eventually we will 
face a fiscal and financial crisis that would be very bad for 
growth and for stability. So, therefore, whatever we do, it is 
very important that we be planning now for a long-term 
improvement in our situation in terms of long-term fiscal 
sustainability.
    At the same time, I think it is important that we keep in 
mind that the recovery is not yet complete. Unemployment 
remains high. The rate of growth is modest. And under current 
law, as you know, on January 1st of 2013, there will be a major 
shift in the fiscal position of the United States, including 
the expiration of a number of tax cuts and other tax 
provisions, together with the sequestration and other 
provisions that would together create a very sharp shift in the 
fiscal stance of the Federal Government.
    I think that we could achieve the very desirable long-run 
fiscal consolidation that we definitely need and we need to do 
soon, but we can do that in a way that does not provide such a 
major shock to the recovery in the near term. And so I am sure 
that Congress will be debating the details of this over the 
next year and trying to take into account both the need for 
protecting the recovery, at the same ensuring that we do 
achieve fiscal sustainability in the long term.
    On the second part of your question, Mr. Chairman, we are 
seeing that manufacturing and industrial production in general 
have been leading the recovery. Housing, which normally does 
lead the recovery, of course is lagging. But, generally, it 
is--and automobiles, of course, being one part of 
manufacturing. But, generally, it is hard to predict, of 
course, what sectors--will have the greatest growth in the 
longer term.
    You asked me earlier in the first question about potential 
growth. We do not see at this point that the very severe 
recession has permanently affected the growth potential of the 
U.S. economy, although, of course, we continue to monitor 
productivity gains and the like. But one concern we do have, of 
course, is the fact that more than 40 percent of the unemployed 
have been unemployed for 6 months or more. Those folks are 
either leaving the labor force or having their skills eroded, 
and although we have not seen much sign of it yet, if that 
situation persists for much longer, then that will reduce the 
human capital that is part of our growth process going forward.
    Chairman Johnson. I have been working with my colleagues in 
the Senate to move forward a set of proposals to update 
securities laws and make it easier for startups and small 
businesses to raise capital while maintaining critical investor 
protections. Do you generally agree that these types of 
proposals will help create jobs and strengthen our economic 
recovery?
    Mr. Bernanke. Well, Mr. Chairman, I do not know the 
specific proposals, but it is certainly true that startup 
companies, companies under 5 years old, create a very 
substantial part of the jobs that are added in our economy. 
And, of course, if there is anything that can be done to 
encourage startups and entrepreneurship, whether it is reducing 
burdensome regulation or providing other kinds of assistance--
of course, Congress makes all the decisions about the 
specifics, but, again, promoting startups is, I think, an 
important direction for job creation. And, in particular, the 
fact that startups and business creation has been quite weak 
during the expansion is one of the reasons that job creation 
has lagged behind the usual recovery pattern.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you.
    Chairman Bernanke, at our last hearing right here in the 
Committee on the European debt crisis, I asked the Federal 
Reserve witness about the exposure of our largest banks to the 
European financial system. The Fed has yet to respond to my 
request for this information. Will you provide the Committee 
with this information regarding the individual exposures of our 
largest banks to Europe?
    Mr. Bernanke. Of course, supervisory information has legal 
protections, but we would be happy to work with the Committee 
to provide you with the information----
    Senator Shelby. Well, we need to know what is going on as 
far as our exposure of our banks to Europe.
    Mr. Bernanke. Yes. We want to make sure you understand the 
situation and have all the information you need to make good 
decisions. I just wanted to add that the SEC, working with 
other agencies, has provided now some guidance and templates to 
banks to provide public information on a quarterly basis about 
their exposures and their hedges. But, yes, we certainly can 
work with you to help you understand everything you need to 
know to make good decisions.
    Senator Shelby. Are you concerned with some exposure of our 
largest banks to Europe?
    Mr. Bernanke. Well, we are concerned in the sense that we 
are paying a lot of attention to it. Our sense is, having done 
a lot of work on this, including asking banks to stress their 
European positions in their current capital stress tests that 
they are doing now, our sense is that the direct exposures of 
U.S. bank to sovereign debt in Europe, particularly that of the 
weaker countries, is quite limited and is well hedged, and that 
those hedges in turn are pretty good hedges, that is, the 
counterparties are diversified and financially strong.
    So if you look more broadly, of course, our banks are 
exposed to European companies and banks, inevitably their major 
trading partners and major financial partners. Again, they have 
been working hard to provide adequate hedges, but let me just 
say I think it is very important to note that if there is a 
major financial problem in Europe, there will be so many 
different channels that would affect the stability of our 
financial system that I would not want to take too much comfort 
from that.
    Senator Shelby. Could you explain to the Committee, to this 
Member, too, the situation as far as credit default swaps and 
why they are not deemed to--certain Nations have defaulted--to 
trigger the action on that? What is going on here? Is this a 
Government intervention in the market? Or what is it?
    Mr. Bernanke. No, sir. There is a private body, the ISDA, 
which makes determinations as to whether a credit event has 
occurred----
    Senator Shelby. When a default happens?
    Mr. Bernanke. When default occurred, that is right. And in 
the case of Greece, which is the relevant issue, thus far there 
has been a so-called private sector involvement, purportedly 
voluntary agreement with the private sector bond holders. And 
there has also been an exchange of bonds by ECB and other 
Government agencies with Greece that essentially give some 
protection to the ECB for its Greek debt holdings.
    The news this morning, I believe, was that the ISDA had 
determined that those two events did not constitute a credit 
event for the purpose of a CDS activation. However----
    Senator Shelby. And why did it not create the dynamic 
there? Why did it not cause voluntary----
    Mr. Bernanke. Well, I guess their view is that so far the 
negotiations have been voluntary. Now, the possibility exists--
the Greek Government has retroactively created so-called 
collective action clauses which it could use in the future to 
force other private sector investors to take losses even if 
they have not agreed to this voluntary deal. And in that case, 
the ISDA would look at it again. and perhaps in that case it 
would declare a default had occurred. But that has not occurred 
yet.
    Senator Shelby. I want to go into one other thing. The 
Dodd-Frank Act created a new position of Vice Chairman for 
Supervision at the Fed, which is subject to Senate 
confirmation. It is almost 2 years later. That was 2 years ago. 
The President has still not nominated anyone for this position.
    Who is currently fulfilling those duties as Vice Chairman 
of Supervision would have at the Fed, if they are being done?
    Mr. Bernanke. They are, of course, being done, and the 
duties are distributed across the Governors and the staff. But 
I would say that the point person, as you know, is Governor 
Tarullo, who is the head of the Bank Supervision Committee and 
has on many occasions testified before this
    Committee on regulatory matters.
    Senator Shelby. Do you believe that that position should be 
filled, nominated and filled?
    Mr. Bernanke. Well, Congress created that position, and, 
yes, I would like to see it filled, and I would also like to 
see the Board filled as well.
    Senator Shelby. And my last question has to do with the 
balance sheet of the Fed, which is approximately, to my 
understanding, about $2.9 trillion. How are you going to shrink 
that? I know you are not going to shrink it now, but do you 
have a plan? I am sure you have talked about it. We have talked 
about it a little bit at times, but that is a huge balance 
sheet to start shrinking, and it probably is not the time to 
shrink it now. I do not have any information on that, but how 
are you going to do that?
    Mr. Bernanke. Senator, we have provided on numerous 
occasions an exit plan. For example, in the minutes, I think 
sometime ago, we provided an agreement of the Committee about 
how we would proceed. In the very short term, we can both, of 
course, allow securities to run off, which we have not been--we 
have been reinvesting them at this point. And we can reduce the 
impact of those securities on the economy, both through various 
sterilization measures and by raising the interest rate we pay 
on reserves to keep those reserves locked up at the Fed.
    Over a longer period of time, of course, we are going to 
have to sell some of the securities and, of course, we will. 
Our goal is to get back to--eventually, at the appropriate 
time, our goal is to get back to a more normal size balance 
sheet consisting only of Treasury securities.
    Senator Shelby. Thank you.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Reed.
    Senator Reed. Well, thank you very much, Mr. Chairman, and 
thank you, Chairman Bernanke. And let me just say I thought 
that the Federal Reserve's white paper on housing was very 
thoughtful, very analytical, and nonprescriptive, which is 
appropriate. I think also, thinking back, such an analytical 
paper might have been extremely useful to us in 2005 or 2006 or 
2007 to alert policy makers to develop it into a housing market 
that proved to be catastrophic. And the final point, I think, 
is that it is fully consistent with the enhanced 
responsibilities under the FSOC that the Federal Reserve must 
display. So on all those points, I think it was appropriate.
    One of the issues that was raised in the paper, which you 
might elaborate on, is that there are short-term programs that 
might in the long term produce more returns, enhanced value to 
the Government and taxpayers. But if they are not pursued, even 
if there is an up-front cost, ironically we could have even a 
further deterioration in the profit, the profitability, assets 
of these GSEs. Can you elaborate on that, Mr. Chairman?
    Mr. Bernanke. Certainly, and I would like just quickly to 
mention to Senator Shelby, who asked about this, that the 
speeches given by Governors Duke and President Dudley are their 
own recognizance. They do not represent official Fed positions, 
and, of course, as you know, Fed members often give their 
views, their own individual views.
    Sorry, Senator Reed. One point that we make is that in a 
typical negotiation between a borrower and a lender, a 
modification or some other arrangement like a short sale or a 
deed in lieu, for example, or other activities like REO-to-
rental are typically taken on a narrow economic basis, the 
benefits of the lender and the borrower, which makes sense in a 
free market economy. But in the current situation, I think it 
is important at least to recognize that the problems in the 
housing sector, including massive numbers of foreclosures, 
uncertainty about the number of houses coming on the market, 
whole neighborhoods with many empty houses, all of those things 
have implications not only for the borrower and the lender but 
also for the neighborhood, for the community, and, of course, 
for the national economy because the weaknesses in the housing 
market, again, as I mentioned earlier, are slowing the pace of 
the recovery, and from the Federal Reserve's point of view are 
probably muting, to some extent, the impact of our low interest 
rate policy because low mortgage rates do not help if people 
cannot get mortgage credit.
    So some of the benefits of actions to improve conditions in 
the housing market go beyond just those of the lender and the 
borrower and accrue to the broader society as well.
    Senator Reed. And one other point you might comment upon is 
that we have several challenges facing us economically, as you 
have illustrated. One is the housing market. The other is 
potential energy spikes. Relatively speaking, it seems to me 
that we have much more ability to influence effectively and 
correctly housing policy here than international energy prices, 
and as a result, it would be, I think, a good investment of our 
time and effort to do so. Is that a fair comment?
    Mr. Bernanke. Well, I think if there was a goal of the 
white paper, it was simply to encourage Congress to look at 
these issues, which represent, I think, one of the directions 
whereby we could be doing something on a policy basis that 
might help the recovery be stronger.
    Senator Reed. Let me turn to the issue of the Volcker Rule, 
which is pending. The European Governments are urging that 
their sovereign equities be sort of treated preferentially in 
the rule, even though, as I understand it--and you might 
correct me--that under the Basel rules there is a zero risk 
weighting to sovereign debt. Is that correct?
    Mr. Bernanke. There is a zero risk weighting yes.
    Senator Reed. So the Greek debt has no risk?
    Mr. Bernanke. Well, the way that it has been handled by the 
European banking authorities at the moment is to force the 
banks to write down their sovereign debt, and that in turn 
affects the amount of capital that they can claim.
    Senator Reed. And in addition, too, the level of capital 
and resulting liquidity for European banks is rather 
substantial relative to ours in terms of the kind of liquidity 
ratios they can bear under Basel. Is that also accurate?
    Mr. Bernanke. That it is lower?
    Senator Reed. No, that they can have much higher liquidity 
than we can or a much higher ratio of debt to equity.
    Mr. Bernanke. Oh, I see. At the moment there are several 
issues. In principle, we are all agreeing to the same set of 
rules, the Basel III rules. But there are at least two 
questions. One has to do with the fact that the ratio of risk-
weighted assets to total assets is lower in Europe than the 
United States, and the question, therefore, is: Are European 
supervisors in some way allowing lower risk weights being put 
on comparable assets? The Basel Committee takes this very 
seriously and has a process underway to try to verify that the 
two continents are operating comparably.
    The other issue is that the Basel rules have not yet been 
implemented in Europe or, of course, in the United States 
either. There is a European Union directive in process which we 
are looking at carefully. It does not in our view completely--
it is not completely consistent with the Basel III agreements, 
but it is not a final document. But we want to be sure that the 
capital rules in Europe do, in fact, adhere to the agreement 
that we all signed on to.
    Senator Reed. Just a final, quick point, Mr. Chairman. In 
the context of the Volcker Rule, you are still looking very, 
very closely at these differentials between European treatment 
of their sovereign debt and ultimately the way the Volcker Rule 
will treat it.
    Mr. Bernanke. Well, the issue that the Europeans and the 
Canadians and the Japanese and others have raised is that 
because there is an exemption for U.S. Treasurys but not for 
foreign sovereigns in the Volcker Rule, they believe they are 
being discriminated against and that the Volcker Rule might 
affect the liquidity and effectiveness of their sovereign debt 
markets. We take this very seriously. We are in close 
discussions with those counterparts, and, of course, we will be 
looking carefully to see if changes are needed, and we will do 
what is necessary.
    Senator Reed. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman. And, Chairman 
Bernanke, I want to follow up on the Volcker Rule. I read with 
interest your comments yesterday, and, frankly, candid 
comments, that the regulators will not be ready to issue the 
rule by the deadline of July, which I think is becoming more 
and more self-evident. I assume the reason for that is that 
because you have 17,000 comments, you have the issues that were 
just raised by Senator Reed with regard to the reaction of 
other markets in the world to what we may do with that rule, 
and the need to conduct a cost/benefit analysis, which is 
likely not to happen by the time we hit the statutory deadline 
in July. Is that correct?
    Mr. Bernanke. Yes, and in addition, it is a multiagency 
rule, and that requires coordination. But I do want to say 
that, of course, we will be working as quickly and as 
effectively as we can to get it done.
    Senator Crapo. Well, I appreciate that. The question I have 
is: As I read the statute, there is a deadline in July for the 
agencies to act, but if the agencies do not act, the rule, 
whatever it is, goes into effect. And the market participants 
are, understandably, I believe, concerned about what they 
should do on July 21st if the agencies have not been able to 
coordinate effectively and promulgate a rule.
    The question I have to you is: Wouldn't it be helpful if 
Congress were to correct that aspect of the statute and make it 
clear that on July 21st we are not going to have a Volcker Rule 
go into effect that does not have the clarification and cost/
benefit analysis and fine-tuning that the agencies are now 
trying to give it?
    Mr. Bernanke. Well, Senator, we certainly do not expect 
people to obey a rule that does not exist. There is a 2-year 
conformance period built into the statute that allows 2 years 
from July of this year before they have to conform to the rule, 
and we will certainly make sure that firms have all the time 
they need to respond. And I think 2 years will probably be 
adequate in that respect.
    Senator Crapo. Well, thank you. I would like to shift 
during the remainder of my questions to the topic of a question 
that the Chairman asked you about whether it is time for us to 
begin more aggressively controlling the spend-out rate in 
Congress' spending habits or whether we need to continue to 
hold off because of the impact on the economy. And I believe, 
as I understood your response, you indicated that in January we 
are going to see tax cuts expire, and we are going to see the 
sequestration impact and a number of other things will happen. 
I believe your answer was that soon we need to take some 
action, and I want to pursue that with you a little more in 
this context.
    We have been having this debate in Congress now for a 
number of years, but I want to go back to the Bowles-Simpson 
Commission, which issued its report 2-plus years ago now. In 
that report it was recognized that there needed to be an easing 
into the aggressive control of spending in Washington, and 
immediately following that, we had the debate over the $800 
billion stimulus bill where the argument was made, you know, it 
is not time to control Federal spending yet, we need another 
year or two before we start getting into the serious control of 
spending. And between then and now, we have basically put about 
another $5 trillion on the national debt, not to count the 
trillions of dollars that have been used to help sustain 
economic activity, whether we agree with them or not from the 
Fed's actions. And we still see the argument being made that it 
is not time yet for us to become aggressively engaged in 
controlling the spending excesses in Washington, even though we 
have over 40 cents of every dollar borrowed today, and the 
budgets that are being proposed continue that trend for the 
next decade.
    I know you do not get heavily engaged in fiscal policy, but 
you have already tiptoed a little bit into those waters, and I 
would like to ask you: When will it be time? I believe it is 
past time. But when will it be time if it is not time now for 
us to start aggressively dealing with the fiscal structure of 
our country on the spending side of the equation?
    Mr. Bernanke. Just a word on the Fed. The Fed's purchase of 
securities actually reduced the deficit because of the interest 
that comes back to the Treasury.
    The two things are not incompatible. You know, you can 
moderate the very near term impact at the same time that you 
make strong and decisive actions to put us on a path--I mean, 
you have not done--you have not taken any actions, you have not 
passed the laws that will bring us on a glidepath into 
sustainability over the next decade or so. And I would add that 
I think one concern there, as I mentioned yesterday, is that 
the 10-year budget window may artificially constrain some of 
the things that Congress should be thinking about because many 
of the issues that we face in terms of not only entitlements 
but other issues as well are multidecade issues. And I think 
you could take strong actions that would be taking place over 
time. I think about the early 1980s Social Security reform that 
phased in a whole bunch of things, including the later 
retirement age, which is still happening today 30 years later. 
So you could take those actions, lock them in, you could get 
the benefit of the confidence there, but it would not have 
necessarily quite as big an impact as the very big shock that 
would otherwise occur next January 1st.
    I am not saying that you cannot do it and take serious 
action. I just think you should balance those objectives.
    Senator Crapo. Well, thank you. I take it that you are 
saying that we need to adopt a long-term plan to deal with this 
crisis.
    Mr. Bernanke. Absolutely.
    Senator Crapo. And I would just observe that at this point 
the budgets that are being proposed simply go the other 
direction. Other than some others, like the Bowles-Simpson 
Commission and others, we still have not got proposals on the 
table here in Congress to deal with that long-term plan, and I 
personally think it is time we get at it.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Well, thank you, Mr. Chairman. Thank you, 
Chairman Bernanke, for your service.
    I read your statement, and, you know, obviously creating 
jobs is the single most important issue in our country for 
families, for our collective economy. When such a large part of 
our GDP is consumer demand, obviously, without income, there is 
not the opportunity to make that demand.
    How would you describe--how are the latest programs of 
quantitative easing and Operation Twist helping us get to a 
more robust growth and creating those opportunities?
    Mr. Bernanke. Well, of course, it is very difficult to 
figure out exactly how to attribute the progress that we have 
made to monetary policy, to fiscal policy, to other sources of 
growth. But if you look at the record, for example, if you look 
back at the Quantitative Easing 2, so-called, in November 2010, 
the concerns at the time were that it would be highly 
inflationary, it would hurt the dollar, that it would not have 
much effect on growth, et cetera. But since November 2010, 
where we have had since then the QE2 and the so-called 
Operation Twist, we have had about 2.5 million jobs created. We 
have seen big gains in stock prices, improvements in credit 
markets. The dollar is about flat. Commodity prices ex oil are 
not much changed. Inflation is doing well in the sense that we 
are looking at about a 2-percent inflation rate for this year.
    So I think that one other point is that in November 2010 we 
had some concerns about deflation, and I think we have sort of 
gotten rid of those and brought ourselves back to a more stable 
inflation environment as well.
    So I think that the record is positive, again, 
acknowledging you cannot necessarily disentangle all the 
different factors. But it is a constructive tool, but obviously 
monetary policy cannot do it all. We need to have good policies 
across the board, including housing, including fiscal policy 
and so on. But looking back, I think that those actions played 
a constructive role.
    Senator Menendez. Well, let me go to that point you just 
made on other elements, housing as one of them. Mr. Dudley, who 
is the president of the Federal Reserve Bank of New York, in a 
recent speech in my home State of New Jersey talked about those 
borrowers who are underwater, and he said, in part, without a 
significant turnaround in home prices and employment, a 
substantial portion of those loans that are deeply underwater 
will ultimately default absent an earned principal reduction 
program. Do you agree with his analysis?
    Mr. Bernanke. No, I want to be clear, the Federal Reserve 
does not have an official position on principal reduction, and 
I think it is a complicated issue. It depends on what your 
objectives are. In terms of avoiding delinquency, there is, I 
think, a reasonable debate in the literature about whether 
reducing principal or reducing payments is more important. So 
that is one issue.
    In terms of issues like mobility for example, ability to 
sell your home and move elsewhere, there are also alternatives 
to principal reduction, including things like deed in lieu and 
short sales.
    So I think it is a complicated issue. There are certainly 
circumstances where principal reduction would be constructive 
and would be cost-effective in terms of reducing default risk 
and improving the economy, but I do not think there is a 
blanket statement that you can make on that.
    Senator Menendez. Well, let me ask you a broader question. 
Right now, Fannie Mae and Freddie Mac currently own or 
guarantee 60 percent of the mortgage market in the country. Do 
you think that their regulator at the FHFA has been aggressive 
enough in using their market power to stabilize the housing 
market?
    Mr. Bernanke. Well, he has to make judgments about the 
effect of those policies on the balance sheet of the GSEs and 
whether or not they meet the conservatorship requirements, and 
he has made judgments about that. I guess what I would just 
suggest is that a variety of different tools can be tried, that 
you can make a mix of different things, and that you can be 
experimental. And the GSEs look to be doing that to some 
extent. We are seeing the experimental REO-to-rental program, 
for example. They have done HARP II. So they have been taking 
steps in that direction, and I think there is a big element 
here of trying to figure out what works best per dollar of 
cost. And FHFA and the GSEs, we may not all agree exactly on 
their particular actions, but I think they are trying some 
things, and we will see what benefits accrue from.
    Senator Menendez. Well, let me just make a final note that 
there are two ways of preserving, you know, the corpus of your 
interest. One is through foreclosure; the other one is through 
looking at the whole process of refinancing and, where 
appropriate, the private sector has taken about 20 percent of 
its portfolio in the banks and said it makes sense to do, you 
know, reductions in principal. So I just worry that our whole 
focus seems to be in those entities, preserving the corpus 
through foreclosure, which at the end of the day has a whole 
other destabilizing element in the marketplace.
    Mr. Bernanke. Senator, I would just like to agree with you 
on that. Foreclosure is very costly not only for the borrower 
and the lender but for the community and for the country. And 
what I was discussing was not whether foreclosure is a good 
thing. I was talking about what are the best ways to address 
the foreclosure issue.
    Senator Menendez. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman. And thank you, Mr. 
Chairman, for being here. I know we alternate between the House 
and Senate going first. This is sort of a postgame interview, 
but we thank you for being here today.
    I want to home in a little bit on the Volcker Rule since 
there has been a lot of testimony about the economy and 
quantitative easing and all those things related to how that 
affects prices and savers and all of that over the last day and 
a half.
    Let me just ask you, with the Volcker Rule--and I think 
most of us are in a place where we are just trying to make it 
work now. We understand that it is passed. Why were Treasurys 
and mortgage-backed securities excluded from the Volcker Rule 
in the first place? It is quite odd that those would be the 
only two instruments that it did not apply to?
    Mr. Bernanke. Well, of course, Congress made that decision, 
and I assume it had to do with a desire to maintain the depth 
and liquidity of the Treasury market.
    Senator Corker. And so by that statement you just made, we 
have taken away the depth of liquidity in all other 
instruments, and thus we have had an outcry from foreign 
Governments and just middle American companies that realize 
they are not going to have the depth of liquidity. And I know 
you focus on economic issues. You are a renowned economist. Is 
that something that is good for our country to lose liquidity 
with those other instruments? Or would we be better off putting 
Treasurys and mortgage-backed securities on the same basis and 
maybe moving them into the Volcker arrangement?
    Mr. Bernanke. Well, there is certainly a tradeoff. There is 
going to be at least some marginal effect from Volcker on 
markets. In principle, there is a market-making exemption, as 
you know, and we are going to try and do our best to clarify 
the distinction between proprietary trading and market making.
    Senator Corker. And you think market making is a good thing 
for our country and by these regulated entities, by virtue of 
that statement. Is that correct?
    Mr. Bernanke. I do, and it is exempted from the Volcker 
Rule, but, of course, we have got to draw that line in a way 
that does not inhibit good market making.
    Senator Corker. Yes. You know, I have talked with some of 
the folks who are advocates for the Volcker Rule, and we have 
tried to come up with a one-sentence solution to allow 
appropriate market making to take place by the regulated 
entities. And some of the people, at least the people we have 
talked to, actually want to see the Volcker Rule used as a way 
to get to Glass-Steagall through the back door.
    By virtue of what you have just said, I think you would 
believe that to be not a good thing for our country. Is that 
correct, or at least as it relates to market making?
    Mr. Bernanke. Well, I have not been an advocate of Glass-
Steagall because I think if you look back at the crisis, the 
separation of commercial and investment banking was not 
particularly helpful. Investment banks obviously were a big 
source of the problem by themselves, separately.
    Senator Corker. Right.
    Mr. Bernanke. But, again, you know, as I was saying before, 
there are tradeoffs. The goal of the Volcker Rule is to reduce 
risk taking by institutions, and we are trying to do that in a 
way that will permit hedging and market making.
    Senator Corker. Well, when you have a rule that, you know, 
people describe like in many ways pornography--in other words, 
you know it when you see it. It is hard, I know, to make a 
rule. And would it be helpful if Congress clarified the fact 
that market making is not intended to be overturned by virtue 
of the Volcker Rule, that market making is a very valid and 
appropriate process for these regulated entities to be involved 
in? And do you think that might help--you know, you have had 
all these comments, you have got all these regulators that are 
trying to come to a conclusion, each with--being pushed, by the 
way, by various constituencies in Congress and outside. Would 
it be helpful to you if we clarified that we as a Congress do 
believe that market making should not be negatively impacted by 
the Volcker Rule.
    Mr. Bernanke. Well, Senator, of course, the Federal Reserve 
pushed for these exemptions, and I think the statute is clear 
that market making is exempt, and we want to do our best to 
make that operational.
    I understand your intent, I hear your intent, that market 
making and hedging should be excluded from proprietary 
trading--or distinguished from proprietary trading.
    Senator Corker. So I think we are, generally speaking, on 
the same page as it relates to the Volcker Rule, and we do not 
want it to do damage to the depth of liquidity unnecessarily 
for lending activities in this country. Is that correct?
    Mr. Bernanke. That is correct.
    Senator Corker. And I think we are on the same page that it 
is probably a legitimate concern for other sovereign 
Governments, like Canada, like Japan, like other ones, to say, 
look, this is incredibly unfair for the largest economy in the 
world to place a tremendous bias on liquidity of Treasurys and 
mortgage-backed securities, unbelievably, but not our own 
sovereign debt. Would you agree that that is a little bit of a 
problem?
    Mr. Bernanke. Well, there is an issue. We are certainly in 
conversations with our partners there. Of course, there is one 
difference, which is that the primary markets for, say, 
Japanese debt are in Japan and, of course, therefore are not 
broadly affected by the Volcker Rule, except to the extent that 
U.S. banks are doing it.
    Senator Corker. Right.
    Mr. Bernanke. But, yes, I agree that we want to make sure 
that we are not doing unnecessary damage to those markets.
    Senator Corker. OK. Do you agree that the zero weighting 
that we place on sovereign debt, especially in this world and 
especially in light of the fact that we are our own worst enemy 
in this country and we still have not been able to, as Senator 
Crapo was alluding to, deal with our longer-term issues with 
the Basel rules that are in place? Should there be a zero risk 
weighting for Treasurys or any other kind of sovereign debt? We 
have seen some big risk out there.
    Mr. Bernanke. Well, none of those securities is completely 
riskless. That is true. We have in the case of non-U.S.--we 
have approached this in various ways. In the case of non-U.S. 
sovereign debt, as I mentioned before, the Europeans have asked 
the banks to write down the value of that debt so in some sense 
it is subtracted from capital one for one. And in the United 
States, we have been making banks--we are not just relying on 
the capital ratio. We are making banks do stress tests and look 
at their European holdings and their hedges and so on to make 
sure that they are safe and sound. So we are not ignoring that 
by any means.
    In the case of U.S. Treasurys, our assumption is that the 
biggest source of risk is interest rate risk as opposed to 
default risk. Under a default, I think the whole Fiscal 
Commission would be in enormous trouble.
    Senator Corker. Right.
    Mr. Bernanke. But we do ask banks to stress test their 
interest rate risk, including their risk of holdings of 
Treasurys and municipalities and so on.
    Senator Corker. Mr. Chairman, I thank you, and I know you 
have received some criticism over the housing white paper, and 
I know we had a brief conversation about it, and I know you 
shared that those were not your ideas necessarily. I do hope 
that in your core area, since the Fed has been pretty active in 
giving advice in outside their core areas, I would love to see 
a white paper on the effect of the financial regulation that we 
just passed on our country. I do not know if that would be 
forthcoming, but I would just suggest, especially since it is 
in your core area, it would be very useful to us as we try to 
work through these details.
    Thank you for your testimony, and thank you, Mr. Chairman.
    Chairman Johnson. Senator Akaka.
    Senator Akaka. Thank you, Mr. Chairman.
    Chairman Bernanke, this is a question which is a follow-up 
on your discussion with Chairman Johnson and Senator Crapo. In 
your testimony you note there has been some modestly 
encouraging data recently, including slightly better 
performance in the labor market, improved consumer sentiment, 
and some increases in manufacturing. But these signs of 
economic recovery are not necessarily reflected yet in the 
experiences of our workers and their families in the 
communities.
    Putting aside a crash in the euro zone, what possible 
setbacks concern you the most with respect to risks and our 
economic recovery? For instance, could action to cut critical 
investments too quickly send the economy back into a slowdown?
    Mr. Bernanke. Well, let me just say first that one of the 
points that I talked about in my remarks was that there still 
is a little bit of a contradiction between the improvement in 
the labor market and the speed of the overall recovery in terms 
of growth. In particular, I mentioned that income had been flat 
for consumers in 2011. The revised data from yesterday actually 
says it was a little bit better than flat but still less than 1 
percent, so you have still got consumption spending growing 
relatively weakly. You have got the fiscal issues that are 
hanging over our heads. So in order to make this a really 
sustainable, strong recovery, we need to have both declines in 
unemployment and strong growth in demand in production, and I 
think that is something we have to watch very carefully.
    In terms of the risks to that, I do have to mention Europe 
because I think that is important. Another is the oil prices. 
We have seen a number of movements up and down in energy 
prices. To some extent, a little bit of the movement in 
commodity prices is essentially inevitable because if the 
economy is growing and the world economy is growing, the demand 
for commodities goes up, and that is going to create some 
tendency toward higher commodity prices. But when you have 
shocks to commodity prices arising from geopolitical events and 
the like, those are unambiguously negative and are bad for both 
households and for the broader economy.
    Housing I think remains a very difficult area. We are 
hoping for price stabilization. We think once people have 
gotten a sense that the housing markets have stabilized, they 
will be much more willing to buy and that banks will be more 
willing to lend. But right now there is still uncertainty about 
where the housing market is going, which I think is troubling. 
And finally, I would mention fiscal policy, which both in the 
short term, in terms of the uncertainty about where fiscal 
policy is going to go over the next year, and in the long term, 
in terms of whether or not Congress and the administration will 
work together to have a sustainable fiscal path, I think both 
of those things are creating some uncertainty and concern that 
do pose some risks to the economy.
    So there are a number of different things, but overall, of 
course, there has been some good news, and, of course, that is 
welcome.
    Senator Akaka. Thank you for that response.
    Chairman Bernanke, as you know, I am most concerned with 
the well-being of consumers. In the current economic climate, 
consumers are confronted with difficult financial decisions, 
and this is the case in Hawaii where many homeowners face 
possible foreclosure, and the average credit card debt of a 
resident is the second highest in the country.
    We know that by saving, individuals can help protect 
themselves during economic downturns and unforeseen life 
events. We also know that our slow economic recovery is 
partially due to low consumption or consumer spending.
    My question to you relates to the intersection of these two 
factors. How can we continue our efforts to promote economic 
recovery and at the same time encourage responsible consumer 
behavior and financial decision making?
    Mr. Bernanke. Well, that is a very good question. Part of 
the problem now is that the demand, the total demand in the 
economy is not adequate to fully utilize the resources of the 
economy, and that is why we talk about the need for greater 
consumer spending and greater investment and so on.
    Of course, we want consumers to be responsible as well, and 
they have, in fact, raised their savings rates and have reduced 
their leverage, and all that is positive.
    I think there are two answers to your question. One is that 
demand comes from places other than consumer spending. It can 
come from capital investment, for example; it can come from net 
exports. Those are some areas where unambiguously higher 
investment creates more capital and more potential growth in 
the future. Greater exports reduces our trade deficit, 
increases our foreign earnings, makes us more competitive 
internationally. So those are alternatives to consumer spending 
to provide growth.
    But then there is also the bit of a paradox that consumer 
spending collectively, if it generates more activity, more 
hiring, more wage income, actually can in the end lead to 
sounder consumer finances than the alternative because if the 
economy is growing strongly and jobs are being created, income 
is being created, then consumers will actually be better off.
    So confidence is really important. If people are confident 
about their job prospects and about their income prospects, it 
can be a self-fulfilling prophecy as they go out and they 
become more confident in their purchasing habits.
    Of course, this all relates, as you have often mentioned, 
to financial literacy and the ability to make good decisions. 
We obviously want people to make decisions that are appropriate 
for their own needs, for their stage in the life cycle, for 
their family responsibilities, for their retirement, and all 
those things. And that remains an important goal even, you 
know, as we worry about trying to get the economy back to full 
employment.
    Chairman Johnson. Senator DeMint.
    Senator Akaka. Thank you very much, Mr. Chairman.
    Senator DeMint. Thank you, Mr. Chairman.
    Mr. Chairman, thank you for being here. You have mentioned 
several times the need for us to have a plan for a sustainable 
fiscal policy. Would a plan that balanced our Federal budget 
within a 10-year window be what you consider a reasonable 
transition toward good fiscal policy?
    Mr. Bernanke. I would go for--at a minimum I would aim 
for--in the next 10 to 15 years, I would aim for eliminating 
the so-called primary deficit, that is, everything except 
interest payments, because once you eliminate the primary 
deficit so that current spending and current revenues are 
equal, that means that the ratio of your debt to your GDP will 
stabilize. And then as you go beyond that, you start to bring 
the debt-to-GDP ratio down.
    You mentioned 10 years. The other thing I would say, as I 
mentioned earlier, is, of course, that many of the things that 
are going to be problems are kicking in after 10 years, and so 
I hope Congress will take, at least for planning purposes, a 
longer-term horizon than that.
    Senator DeMint. In my conversations with some of your 
Governors and some of the central bankers around the world, 
there seems to be a broad consensus that there is not the 
political will here, Europe, and many other places to actually 
get control of fiscal policy, and that much of our monetary 
policy here and around the world is really driven by trying to 
clean up the mess that policy makers make. And you may not want 
to comment on that, but quantitative easing, for instance, is 
dealing with the tremendous we have created as policy makers, 
and what we see in Europe happening today, again, dealing with 
debt but from a monetary policy rather than fiscal policy.
    My concern now--and I know you meet with central bankers 
all over the world regularly, and as I see what appears to be a 
coordinated increase in money supplies here, Europe, and other 
places, it may not be formal coordination, I do not know. But 
there appears to be an effort to keep relative values of 
currencies the same as we increase our monetary supply, others 
are doing it. And I would just love to have some insight beyond 
just the individual policies here as to what degree you feel 
like you can be honest with us as the ones who primarily create 
the problems. Is it at least within the--is it true that a lot 
of monetary policy is now driven by irresponsible fiscal policy 
from policy makers? And is there an effort for central banks 
around the world to work together to deal with that?
    Mr. Bernanke. I would say no to both questions. Our 
monetary policy is aimed at our dual mandate, which is maximum 
employment and price stability. We are trying to set monetary 
policy at a setting that will help the economy recover in the 
context of price stability. I think it is interesting that 
other countries are following our basic approach. It is not 
because we have coordinated in any way. It is because they face 
similar situations--weak recoveries, low inflation, and the 
fact that interest rates are close to zero, and so some of 
these quantitative easing type policies are the main 
alternative once you have got interest rates close to zero.
    So, no, this is not an attempt to cover up or clean up 
fiscal policy. On the other hand, I think the concerns that 
people express both about the United States and other countries 
about the political will and the ability of the political 
system to deliver better fiscal results over the long term, I 
think that is an issue that a lot of people are concerned 
about. I have noted on previous occasions that the reason S&P 
downgraded U.S. Treasurys last August was not because of the 
size of the debt but because they took the view that our 
political system was not adequately progressing on making long-
term sustainable fiscal plans.
    I hope we can prove them wrong. I think that this January 
1st event where so many things, if left unchanged, will be 
happening that would be I think on net contractionary, I hope 
that will be sort of a trigger point to sort of force Congress 
to say, well, how are we going to solve this problem? And so, 
of course, I realize how difficult it is politically, but I 
encourage you to make every effort to help restore fiscal 
sustainability in the United States.
    Senator DeMint. Well, my concern is that I really do 
believe obviously we would not have $16 trillion in debt going 
on 25 or whatever the projections are if we had not been 
irresponsible as policy makers over many years. I am not 
blaming that on any President or party, but it is clearly a 
problem.
    But as has been pointed out by the Wall Street Journal 
today and in other articles in financial magazines, the loose 
monetary policy is compounding the potential problems in the 
future. And I think as Senator Shelby talked about, the need 
for transparency, the need to understand where we are headed 
with this is pretty important to us as policy makers, first for 
you to be brutally honest, and maybe even more than you have 
been today, that we are on an unsustainable path. It hurts me 
to hear you say in 10 or 20 years we need to bring it under 
control when the analysis I have seen of worldwide available 
credit suggests that a 5-year window may be tough for us on our 
current pace as far as borrowing the money.
    But we seem to have a compounding and growing problem and 
not a sense of urgency that one would expect given where we are 
from a political side and now a monetary system around the 
world that seems to be potentially making that much worse. I 
will just let you comment, and then I will yield back.
    Mr. Bernanke. Well, I would only say that I do not mean 
that no actions should be taken until 10 or 20 years. I mean 
that the plan needs to be a long-run plan because our problems 
are long-run problems, and that looking only at 2013 is not 
going to be helpful. We need to look at the whole horizon.
    Chairman Johnson. Senator Bennet.
    Senator Bennet. Thank you, Mr. Chairman. And thank you, Mr. 
Chairman, for being here today.
    I wanted to focus my questions on the economy with you 
since you actually know what you are talking about. But before 
I do that, I wanted to go back to an answer that you made 
earlier on interest rates. You had said that you thought the 
risk of default was not a serious one-- obviously, it would be 
catastrophic if it happened--but that the risk that you are 
worrying about is interest rate risk for our financial 
institutions and economy. Could you talk a little bit more 
about that, what would cause that interest rate risk and what 
the effects would be of a more normalized interest rate than 
the one we have today?
    Mr. Bernanke. Well----
    Senator Bennet. Which is at a historic low, isn't it?
    Mr. Bernanke. Right. So both short-term and long-term 
interest rates are quite low. You know, our current 
expectation, as we have said in our statement, is that the 
short-run rate will stay low for a good bit more time. But 
eventually at some point, the economy will strengthen, 
inflation may begin to rise, and the Fed will have to begin to 
raise short-term interest rates. At the same time, stronger 
economic conditions here and globally will cause longer-term 
rates to begin to rise, and that is a good thing. That is a 
normal, healthy thing as the economy returns to normal. But, of 
course, depending on how your portfolio is structured, you 
could have the risk of losing money on holdings of bonds. And 
we just want to make sure that banks understand their risks and 
that they are well protected and hedged against whatever course 
interest rates might take in the future. I mean, eventually 
they will begin to rise. We just do not know when.
    Senator Bennet. Senator Akaka made the point earlier that 
we have seen some economic growth, but it has not yet hit home 
in many ways. I have a chart that is not useful for this 
because it is so small, but I will carve it in the air for you. 
The top line is GDP growth, and what we see is that our GDP is 
actually higher than it was before we went into this recession, 
which surprises a lot of people when they hear that our 
economic output is higher today than it was when the recession 
started. It has gone up since the early 1990s. Productivity has 
risen mightily over that same period of time because--think of 
our response to competition from abroad and the use of 
technology and then the recession itself, which drove the 
productivity index straight up because firms were trying to 
figure out how to get through with fewer people.
    As you observed, median family income has actually fallen 
over the decade, and we are producing that economic output with 
23 or 24 million people that are either unemployed or 
underemployed in this economy. So we are in a sense stuck with 
a gap of economic output and productivity here and wages and 
jobs here.
    As a learned economist, can you help me think about the 
kinds of things that would begin to lift that median income 
curve in the right direction, that job curve in the right 
direction? And I would encourage you to think broadly about 
that so education and immigration and whatever it is you think 
will----
    Mr. Bernanke. Well, sure----
    Senator Bennet. ----because that, unlike the political 
stuff we are all talking about in Washington that actually does 
not make any sense to people at home, that is the issue that 
they are confronting, is what I just described.
    Mr. Bernanke. Of course. Well, let us not belittle the 
impact of getting back to full employment. That would obviously 
be very helpful, and that is what the Fed is trying to do with 
our monetary policy.
    But more generally, there are a couple of interesting 
things. One is that the profit share of GDP is unusually high, 
the share of income going to wage earners is lower than normal, 
and that is a bit of a puzzle. It may have to do with 
globalization, it may have to do with the fact that a lot of 
profits are earned overseas rather than domestically and so on. 
So that is one question.
    But I think more generally, there is a whole raft of issues 
associated with globalization, including trade competition, 
including the fact that low-skilled workers are now effectively 
competing with low-skilled workers around the world, advent of 
new technologies provides a lot of benefits to people with 
greater education and greater training and creates 
discrepancies between them and people with less training and 
education.
    So from that there are not a lot of good answers, but 
certainly the most basic thing is training and skills because 
those are highly rewarded in our society still, but the low-
skilled workers are effectively competing with low-skilled 
workers globally, and it is very difficult for them to earn a 
high income.
    Senator Bennet. I am out of time, Mr. Chairman. I realize 
that. I just would say that the worst the unemployment rate got 
for people in this recession with a college degree was 4.5 
percent, and there is a lot, I think, that we can learn from 
that.
    I will submit my other questions for the record. Thank you 
for being here today.
    Mr. Bernanke. Thank you.
    Chairman Johnson. Senator Vitter.
    Senator Vitter. Thank you, Mr. Chairman. And thank you, Mr. 
Chairman, for being here.
    I am concerned about some of the negatives, which could 
clearly grow over time, about the zero interest rate policy. 
What would you consider the list of present or potential 
negatives? And how do you go about sort of monitoring those to 
always determine whether this continues to make sense in your 
mind?
    Mr. Bernanke. Well, a number of issues have been raised. 
One that is often raised is the return to savers--with low 
interest rates, that we not penalize savers. We are aware of 
that. We take that into account in our discussions. But as I 
mentioned yesterday, of total household wealth, something only 
less than 10 percent, according to the Survey of Consumer 
Finances, is in fixed income instruments like CDs or bonds and 
so on. Most household wealth is in other forms--equity, small 
business ownership, real estate, et cetera. And our efforts to 
strengthen the economy will increase the returns and value of 
those assets, and so on net our activities are raising 
household wealth overall even if they are reducing the interest 
rate you can receive on fixed income assets. And, of course, 
keeping inflation low also helps in that respect.
    The second issue that we hear a lot about is pension and 
insurance that low interest rates increase the contributions 
that those companies have to make. Again, we have had many 
conversations with those folks about these issues. I would say 
that it is a serious issue and one that we look at. There, 
again, are countervailing factors. If you look, for example, at 
compensation to workers, which includes pension contributions, 
it remains quite low, like 2 percent a year growing. So these 
pension contributions are significant but not massive. And on 
the other side of the balance sheet, of course, pension funds 
and insurance companies have to invest in the economy. And, 
once again, a stronger economy produces higher returns in 
equity markets, real estate markets, and the like.
    The third issue, which is very tricky, has to do with 
possibly creating financial bubbles of various kinds. People 
have different views about that. Our view is basically that the 
first line of defense against bubbles should be what is called 
macroprudential supervision. There should be supervisory 
approaches looking at what is happening in the system and 
making sure that financial institutions are as strong as 
possible through capital, for example, and we have greatly 
upgraded our ability to monitor the financial system since the 
crisis, and we are both trying to identify potential problems 
but also making sure the institutions are sufficiently strong 
that if there is a problem, they will be able to withstand it.
    If those things do not seem to be working, then we are 
prepared, I think, to take that into account in monetary 
policy. But those are some issues, and we are aware of them.
    Senator Vitter. One thing that might have been first on my 
list is commodity prices, a weak dollar pushing investment 
toward commodities, pushing up commodity prices. And, of 
course, now the most obvious example of that is gasoline 
prices.
    Briefly, how would you analyze that? And when does that 
start becoming such a negative that you rethink this?
    Mr. Bernanke. So I think there are two ways in which low 
interest rate policies realistically would affect commodity 
prices. First would be through weakening the dollar, but the 
dollar has been pretty stable. It really has not moved much 
since, for example, November 2010 when we introduced QE2. The 
second is by creating growth both here and perhaps to some 
extent internationally. Higher growth increases demand for 
commodities. That raises prices. That is kind of inevitable. If 
you want to have a growing economy, that is going to put more 
pressure on oil prices and so on.
    So those two things I think have not been a big problem. I 
think particularly if you look at commodities, the one 
commodity that has been particularly troublesome has been oil, 
and currently, I mean, it is quite obvious that there are a 
number of factors affecting the supply of oil, including 
concerns about Iran and supply issues in Africa and so on that 
are contributing to that increase.
    Senator Vitter. Most of the quantitative easing 
announcements have more or less coincided with increases in oil 
prices. Are you saying that is largely a coincidence or not?
    Mr. Bernanke. No, it is not entirely a coincidence. First 
of all, if you look over longer periods, it is not quite as 
close a correlation as you might think. But I think part of the 
reason, again, that there is a coincidence is because to the 
extent that monetary policy is structured in a way to increase 
growth expectations, that feeds into commodity prices through 
the demand channel. So that is one link that I do agree exists.
    Senator Vitter. And if I can just wrap up, Mr. Chairman, at 
what point, particularly with regard to oil, at what point 
would that factor driving up prices be a sufficient negative in 
terms of economic growth that you would pause in terms of this 
2014 zero interest rate policy?
    Mr. Bernanke. Well, we will always keep looking at it, but 
our analysis suggests that the other benefits of low interest 
rates through a whole range of asset prices, through increased 
consumption and investment spending and so on, outweighs 
reasonable estimates of the effects of that on commodity prices 
in terms of growth. And, again, I think the reason we have seen 
these sharp movements has more to do with the international 
situation than with U.S. monetary policy. But, obviously, it is 
a negative and something we want to keep monitoring.
    Senator Vitter. Thank you, Mr. Chairman.
    Chairman Johnson. Chairman Bernanke, I would like to thank 
you for your testimony today. There is a vote going on which 
requires my attention, and I will turn over the gavel to 
Senator Schumer for a few last questions.
    Senator Schumer [presiding]. Well, I would like to 
recognize Senator Schumer to ask 5 minutes of questions. Thank 
you, Mr. Chairman.
    The first question is about the highway bill, the surface 
transportation bill that is on the floor. It will, according to 
its sponsors, create or save 2 million jobs, has broad 
bipartisan support. APTA, the Public Transportation 
Association, estimates that every $1 billion of Federal 
investments in highways creates 36,000 jobs.
    What impact would passing long-term transportation 
reauthorization legislation have on the pace of economic 
growth?
    Mr. Bernanke. I do not know enough about the details of 
that bill to give you any kind of estimate. I just would like 
to make one observation, which is the jobs part is important. 
That is part of helping the recovery. But I think when you 
think about long-term infrastructure investments, you also want 
to think about whether these are good investments in terms of 
the returns.
    President Eisenhower's investment, as you know, in the 
interstate system produced tremendous dividends in terms of 
reduced transportation costs and integration of our economy. So 
I would urge you--and I know you are doing this--as you approve 
projects that you take very seriously that you want to do the 
ones that are going to be more productive.
    Senator Schumer. That goes to the quality of the project, 
but at this point in time, that kind of stimulus in a sense 
would serve the economy well and would be needed.
    Mr. Bernanke. Well, there are different ways to provide 
stimulus----
    Senator Schumer. Assume it would be spent decently well.
    Mr. Bernanke. Well, Senator, you know, there are different 
ways to provide stimulus. Infrastructure, if it is well 
designed and has a good return, I think is often a good 
approach. But you understand that I do not want to----
    Senator Schumer. Endorse a specific bill.
    Mr. Bernanke. ----endorse a specific bill.
    Senator Schumer. No, I did not ask you that because you 
made the caveat it may not have good projects. But I am just 
making the point that at this time when you have said the 
economy is moving forward but at a slow pace, taking away 
infrastructure money might hurt the economy, adding 
infrastructure money would certainly help the economy. And, of 
course, you want to do it as well as possible so there are 
other long-term benefits. Is that a fair recapitulation?
    Mr. Bernanke. Yes, although, again----
    Senator Schumer. Say no more.
    Mr. Bernanke. ----there are various alternatives.
    Senator Schumer. OK. Yes, but those alternatives are not--
this is a yes-or-no situation for us now. Money market funds. 
We all remember the dark days of the fall of 2008, the panic 
that ensued when a large money market fund broke the buck and 
there was a run on the funds. The SEC instituted some reforms, 
as you know, in 2010 to address the problems that led to the 
run in 2008.
    However, Chairman Schapiro and FSOC, you remember, have 
made it clear they believe more should be done, so in their 
recent reports they have discussed a few options--this was in 
the newspaper--including a requirement that would lock up a 
portion of investors' money and a proposal to require funds to 
abandon the stable $1-a-share net asset value. The proposals 
have the potential to fundamentally change the nature of the 
product. Some would say it would drive it out of existence. We 
would not have money market funds. Obviously, they play an 
important role in short-term financing of many different types 
of businesses.
    What are the risks to the economy and financial system if 
we were to fundamentally alter the nature of the money market 
funds? What do you think of the two different proposals made to 
strengthen them? I am particularly interested--I have heard 
that if investors have to keep 3 percent or a certain 
percentage aside, you know, and cannot pull it out right away, 
it is not worth an investment to them anymore--it is not worth 
investing in a money market fund to them anymore.
    Mr. Bernanke. Well, first, as you pointed out, the SEC has 
already done some constructive things in terms of, for example, 
improving liquidity requirements. I think, though, the Federal 
Reserve in general and I personally would have to agree that 
there are still some risks in the money market mutual funds. In 
particular, they still could be subject to runs, and one of the 
implications of Dodd-Frank is that some of the tools that we 
used in 2008 to arrest the run on the funds are no longer 
available. As you know, the Treasury can no longer provide the 
ad hoc insurance it provided. The Fed's ability to lend to 
money market mutual funds is greatly restricted because of the 
fact that we would have to take a hair cut on their assets, and 
that is not going to work with their economics.
    So we support the SEC's attempts to look at alternatives, 
and you mentioned some different things, but I believe their 
idea is to put out a number of alternative strategies. One 
would be to go away from the fixed net asset value approach. I 
think that the industry will reject that pretty categorically, 
and so then the question is what else could be done.
    One approach would be essentially to create some more 
capital. They have very limited capital at this point, and 
there might be ways maybe over time to build up the capital 
base. So that is one possible approach. And then either 
complementing that or as a separate approach would be something 
that involved not allowing the investors to draw out 100 
percent immediately.
    Senator Schumer. Right.
    Mr. Bernanke. If you think about that, what that really 
does is that it makes it unattractive to be the first person to 
be to withdraw your money and, therefore, it reduces the risk 
of runs considerably. It also has an investor protection 
benefit, which is that if you are ``a slow investor'' and you 
are not monitoring the situation moment by moment and so you 
are the last guy to take your money out, you are still 
protected because there is this 3 percent, or whatever----
    Senator Schumer. But I have heard from some investors and 
from some funds that, given the low margin that money market 
funds pay, it would just end the business more or less. Or 
certainly I have heard from investors that they would not put 
money in if they knew they had to keep 2 or 3 percent in there. 
Does that worry you?
    Mr. Bernanke. Well, it is certainly a difficult time 
because interest rates are very low and, therefore, their 
attractiveness is less. I do not know. I think you would have 
to have some kind of discussion here because part of the reason 
that investors invest in money market mutual funds is because 
they think they are absolutely 100 percent safe and there is no 
way to lose money. And that is not true.
    Senator Schumer. We learned that the hard way.
    Mr. Bernanke. If that is not true, then we have to make 
sure that investors are aware and that we take whatever actions 
are necessary to protect their investment.
    Senator Schumer. Do you think money market funds play a 
useful role, though, in the economy and we should try to keep 
them going?
    Mr. Bernanke. Well, generally speaking, they do, and they 
are a useful source of short-run money. And, again, please do 
not overread this, but Europe does not have any, and they have 
a financial system--there are different ways of structuring----
    Senator Schumer. And they are in great shape.
    Mr. Bernanke. They are in great shape, yes. There are many 
ways to structure your financial system, but, again, I envision 
that money market mutual funds will be part of the future of 
the U.S. financial system.
    Senator Schumer. Thank you, Mr. Chairman. I appreciate it.
    Senator Reed [presiding]. There are no more questions. 
Thank you, Mr. Chairman. On behalf of the Chairman, unless I am 
instructed otherwise, I will adjourn the hearing.
    Mr. Bernanke. Thank you.
    [Whereupon, at 11:45 a.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]

               PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON

    Today I welcome Chairman Bernanke back to this Committee to deliver 
the Federal Reserve's Semiannual Monetary Report to Congress.
    There are reasons to be optimistic about our Nation's economic 
recovery. The U.S. economy has expanded for 10 straight quarters, and 
private sector employment has increased for 23 straight months. Private 
employers added 2.1 million jobs last year, the most since 2005.
    But there are also reasons to be concerned, such as the European 
debt crisis and the continuing drag of the housing market on the 
broader economy. This Committee has paid close attention to these two 
issues and held numerous hearings. While I remain hopeful that we are 
moving in the right direction, we must continue to monitor the 
situation in Europe closely. On housing, there is a variety of policy 
proposals--some that do not require an act of Congress--that should be 
considered to improve the housing market. I want to thank Governor Duke 
for her thoughtful testimony on Tuesday before this Committee on the 
Federal Reserve's white paper on options to improve the housing market.
    An additional challenge, the sharp increase in oil prices, has the 
potential to impede the economic recovery. Americans continue to 
grapple with higher fuel costs when they fill up their cars or heat 
their homes. It is important that oil markets are closely monitored for 
signs of manipulation or supply disruption, and I look forward to 
hearing the Fed's views on how rising oil prices may affect consumer 
spending and economic growth.
    I appreciate all the Fed has done to ensure continued economic 
recovery. Chairman Bernanke, I look forward to hearing more from you on 
the Fed's recent actions and possible future actions to protect our 
economy.
    Congress also has an important role in making sure the economy 
continues to grow, and more Americans continue to find the jobs they 
need. This week, the full Senate continues to consider the 
Transportation bill. This bill includes the bipartisan effort of this 
Committee to update our Nation's public transit infrastructure and 
create jobs. I am also hopeful that the Senate can find consensus on 
capital formation initiatives, the topic of another hearing next week 
before this Committee, to promote job creation while protecting 
investors.
    With so many Americans in search of work, it is not too late for 
bipartisan action to create jobs and promote sustainable growth. I look 
forward to your views, Chairman Bernanke, on these and other steps 
Congress can take to improve our Nation's economy.
                                 ______
                                 
                 PREPARED STATEMENT OF BEN S. BERNANKE
       Chairman, Board of Governors of the Federal Reserve System
                             March 1, 2012

    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 recovery of the U.S. economy continues, but the pace of 
expansion has been uneven and modest by historical standards. After 
minimal gains in the first half of last year, real gross domestic 
product (GDP) increased at a 2\1/4\ percent annual rate in the second 
half. \1\ The limited information available for 2012 is consistent with 
growth proceeding, in coming quarters, at a pace close to or somewhat 
above the pace that was registered during the second half of last year.
---------------------------------------------------------------------------
     \1\ Data for the fourth quarter of 2011 from the national income 
and product accounts reflect the advance estimate released on January 
27, 2012.
---------------------------------------------------------------------------
    We have seen some positive developments in the labor market. 
Private payroll employment has increased by 165,000 jobs per month on 
average since the middle of last year, and nearly 260,000 new private-
sector jobs were added in January. The job gains in recent months have 
been relatively widespread across industries. In the public sector, by 
contrast, layoffs by State and local governments have continued. The 
unemployment rate hovered around 9 percent for much of last year but 
has moved down appreciably since September, reaching 8.3 percent in 
January. New claims for unemployment insurance benefits have also 
moderated.
    The decline in the unemployment rate over the past year has been 
somewhat more rapid than might have been expected, given that the 
economy appears to have been growing during that time frame at or below 
its longer-term trend; continued improvement in the job market is 
likely to require stronger growth in final demand and production. 
Notwithstanding the better recent data, the job market remains far from 
normal: The unemployment rate remains elevated, long-term unemployment 
is still near record levels, and the number of persons working part 
time for economic reasons is very high. \2\
---------------------------------------------------------------------------
     \2\ In January, 5\1/2\ million persons among those counted as 
unemployed--about 43 percent of the total--had been out of work for 
more than 6 months, and 8\1/4\ million persons were working part time 
for economic reasons.
---------------------------------------------------------------------------
    Household spending advanced moderately in the second half of last 
year, boosted by a fourth-quarter surge in motor vehicle purchases that 
was facilitated by an easing of constraints on supply related to the 
earthquake in Japan. However, the fundamentals that support spending 
continue to be weak: Real household income and wealth were flat in 
2011, and access to credit remained restricted for many potential 
borrowers. Consumer sentiment, which dropped sharply last summer, has 
since rebounded but remains relatively low.
    In the housing sector, affordability has increased dramatically as 
a result of the decline in house prices and historically low interest 
rates on conventional mortgages. Unfortunately, many potential buyers 
lack the down payment and credit history required to qualify for loans; 
others are reluctant to buy a house now because of concerns about their 
income, employment prospects, and the future path of home prices. On 
the supply side of the market, about 30 percent of recent home sales 
have consisted of foreclosed or distressed properties, and home vacancy 
rates remain high, putting downward pressure on house prices. More-
positive signs include a pickup in construction in the multifamily 
sector and recent increases in homebuilder sentiment.
    Manufacturing production has increased 15 percent since the trough 
of the recession and has posted solid gains since the middle of last 
year, supported by the recovery in motor vehicle supply chains and 
ongoing increases in business investment and exports. Real business 
spending for equipment and software rose at an annual rate of about 12 
percent over the second half of 2011, a bit faster than in the first 
half of the year. But real export growth, while remaining solid, slowed 
somewhat over the same period as foreign economic activity decelerated, 
particularly in Europe.
    The members of the Board and the presidents of the Federal Reserve 
Banks recently projected that economic activity in 2012 will expand at 
or somewhat above the pace registered in the second half of last year. 
Specifically, their projections for growth in real GDP this year, 
provided in conjunction with the January meeting of the Federal Open 
Market Committee (FOMC), have a central tendency of 2.2 to 2.7 percent. 
\3\ These forecasts were considerably lower than the projections they 
made last June. \4\ A number of factors have played a role in this 
reassessment. First, the annual revisions to the national income and 
product accounts released last summer indicated that the recovery had 
been somewhat slower than previously estimated. In addition, fiscal and 
financial strains in Europe have weighed on financial conditions and 
global economic growth, and problems in U.S. housing and mortgage 
markets have continued to hold down not only construction and related 
industries, but also household wealth and confidence. Looking beyond 
2012, FOMC participants expect that economic activity will pick up 
gradually as these headwinds fade, supported by a continuation of the 
highly accommodative stance for monetary policy.
---------------------------------------------------------------------------
     \3\ See, table 1, ``Economic Projections of Federal Reserve Board 
Members and Federal Reserve Bank Presidents, January 2012'', of the 
Summary of Economic Projections available at Board of Governors of the 
Federal Reserve System (2012), ``Federal Reserve Board and Federal Open 
Market Committee Release Economic Projections From the January 24-25 
FOMC Meeting'', press release, January 25, www.federalreserve.gov/
newsevents/press/monetary/20120125b.htm; also available in Part 4 of 
the February 2012 Monetary Policy Report to the Congress.
     \4\ Ben S. Bernanke (2011), ``Semiannual Monetary Policy Report to 
the Congress'', statement before the Committee on Financial Services, 
U.S. House of Representatives, July 13, www.federalreserve.gov/
newsevents/testimony/bernanke20110713a.htm.
---------------------------------------------------------------------------
    With output growth in 2012 projected to remain close to its longer-
run trend, participants did not anticipate further substantial declines 
in the unemployment rate over the course of this year. Looking beyond 
this year, FOMC participants expect the unemployment rate to continue 
to edge down only slowly toward levels consistent with the Committee's 
statutory mandate. In light of the somewhat different signals received 
recently from the labor market than from indicators of final demand and 
production, however, it will be especially important to evaluate 
incoming information to assess the underlying pace of economic 
recovery.
    At our January meeting, participants agreed that strains in global 
financial markets posed significant downside risks to the economic 
outlook. Investors' concerns about fiscal deficits and the levels of 
Government debt in a number of European countries have led to 
substantial increases in sovereign borrowing costs, stresses in the 
European banking system, and associated reductions in the availability 
of credit and economic activity in the euro area. To help prevent 
strains in Europe from spilling over to the U.S. economy, the Federal 
Reserve in November agreed to extend and to modify the terms of its 
swap lines with other major central banks, and it continues to monitor 
the European exposures of U.S. financial institutions.
    A number of constructive policy actions have been taken of late in 
Europe, including the European Central Bank's program to extend 3-year 
collateralized loans to European financial institutions. Most recently, 
European policy makers agreed on a new package of measures for Greece, 
which combines additional official-sector loans with a sizable 
reduction of Greek debt held by the private sector. However, critical 
fiscal and financial challenges remain for the euro zone, the 
resolution of which will require concerted action on the part of 
European authorities. Further steps will also be required to boost 
growth and competitiveness in a number of countries. We are in frequent 
contact with our counterparts in Europe and will continue to follow the 
situation closely.
    As I discussed in my July testimony, inflation picked up during the 
early part of 2011. \5\ A surge in the prices of oil and other 
commodities, along with supply disruptions associated with the disaster 
in Japan that put upward pressure on motor vehicle prices, pushed 
overall inflation to an annual rate of more than 3 percent over the 
first half of last year. \6\ As we had expected, however, these factors 
proved transitory, and inflation moderated to an annual rate of 1\1/2\ 
percent during the second half of the year--close to its average pace 
in the preceding 2 years. In the projections made in January, the 
Committee anticipated that, over coming quarters, inflation will run at 
or below the 2 percent level we judge most consistent with our 
statutory mandate. Specifically, the central tendency of participants' 
forecasts for inflation in 2012 ranged from 1.4 to 1.8 percent, about 
unchanged from the projections made last June. \7\ Looking farther 
ahead, participants expected the subdued level of inflation to persist 
beyond this year. Since these projections were made, gasoline prices 
have moved up, primarily reflecting higher global oil prices--a 
development that is likely to push up inflation temporarily while 
reducing consumers' purchasing power. We will continue to monitor 
energy markets carefully. Longer-term inflation expectations, as 
measured by surveys and financial market indicators, appear consistent 
with the view that inflation will remain subdued.
---------------------------------------------------------------------------
     \5\ Bernanke, ``Semiannual Monetary Policy Report to the 
Congress'' (see, n. 4).
     \6\ Inflation is measured using the price index for personal 
consumption expenditures.
     \7\ See, table 1 available at Board of Governors, ``Federal 
Reserve Board and Federal Open Market Committee Release Economic 
Projections'' (see, n. 3).
---------------------------------------------------------------------------
Monetary Policy
    Against this backdrop of restrained growth, persistent downside 
risks to the outlook for real activity, and moderating inflation, the 
Committee took several steps to provide additional monetary 
accommodation during the second half of 2011 and early 2012. These 
steps included changes to the forward rate guidance included in the 
Committee's postmeeting statements and adjustments to the Federal 
Reserve's holdings of Treasury and agency securities.
    The target range for the Federal funds rate remains at 0 to \1/4\ 
percent, and the forward guidance language in the FOMC policy statement 
provides an indication of how long the Committee expects that target 
range to be appropriate. In August, the Committee clarified the forward 
guidance language, noting that economic conditions--including low rates 
of resource utilization and a subdued outlook for inflation over the 
medium run--were likely to warrant exceptionally low levels for the 
Federal funds rate at least through the middle of 2013. By providing a 
longer time horizon than had previously been expected by the public, 
the statement tended to put downward pressure on longer-term interest 
rates. At the January 2012 FOMC meeting, the Committee amended the 
forward guidance further, extending the horizon over which it expects 
economic conditions to warrant exceptionally low levels of the Federal 
funds rate to at least through late 2014.
    In addition to the adjustments made to the forward guidance, the 
Committee modified its policies regarding the Federal Reserve's 
holdings of securities. In September, the Committee put in place a 
maturity extension program that combines purchases of longer-term 
Treasury securities with sales of shorter-term Treasury securities. The 
objective of this program is to lengthen the average maturity of our 
securities holdings without generating a significant change in the size 
of our balance sheet. Removing longer-term securities from the market 
should put downward pressure on longer-term interest rates and help 
make financial market conditions more supportive of economic growth 
than they otherwise would have been. To help support conditions in 
mortgage markets, the Committee also decided at its September meeting 
to reinvest principal received from its holdings of agency debt and 
agency mortgage-backed securities (MBS) in agency MBS, rather than 
continuing to reinvest those proceeds in longer-term Treasury 
securities as had been the practice since August 2010. The Committee 
reviews the size and composition of its securities holdings regularly 
and is prepared to adjust those holdings as appropriate to promote a 
stronger economic recovery in the context of price stability.
    Before concluding, I would like to say a few words about the 
statement of longer-run goals and policy strategy that the FOMC issued 
at the conclusion of its January meeting. The statement reaffirms our 
commitment to our statutory objectives, given to us by the Congress, of 
price stability and maximum employment. Its purpose is to provide 
additional transparency and increase the effectiveness of monetary 
policy. The statement does not imply a change in how the Committee 
conducts policy.
    Transparency is enhanced by providing greater specificity about our 
objectives. Because the inflation rate over the longer run is 
determined primarily by monetary policy, it is feasible and appropriate 
for the Committee to set a numerical goal for that key variable. The 
FOMC judges that an inflation rate of 2 percent, as measured by the 
annual change in the price index for personal consumption expenditures, 
is most consistent over the longer run with its statutory mandate. 
While maximum employment stands on an equal footing with price 
stability as an objective of monetary policy, the maximum level of 
employment in an economy is largely determined by nonmonetary factors 
that affect the structure and dynamics of the labor market; it is 
therefore not feasible for any central bank to specify a fixed goal for 
the longer-run level of employment. However, the Committee can estimate 
the level of maximum employment and use that estimate to inform policy 
decisions. In our most recent projections in January, for example, FOMC 
participants' estimates of the longer-run, normal rate of unemployment 
had a central tendency of 5.2 to 6.0 percent. \8\ As I noted a moment 
ago, the level of maximum employment in an economy is subject to 
change; for instance, it can be affected by shifts in the structure of 
the economy and by a range of economic policies. If at some stage the 
Committee estimated that the maximum level of employment had increased, 
for example, we would adjust monetary policy accordingly.
---------------------------------------------------------------------------
     \8\ See, table 1 available at Board of Governors, ``Federal 
Reserve Board and Federal Open Market Committee Release Economic 
Projections'' (see, n. 3).
---------------------------------------------------------------------------
    The dual objectives of price stability and maximum employment are 
generally complementary. Indeed, at present, with the unemployment rate 
elevated and the inflation outlook subdued, the Committee judges that 
sustaining a highly accommodative stance for monetary policy is 
consistent with promoting both objectives. However, in cases where 
these objectives are not complementary, the Committee follows a 
balanced approach in promoting them, taking into account the magnitudes 
of the deviations of inflation and employment from levels judged to be 
consistent with the dual mandate, as well as the potentially different 
time horizons over which employment and inflation are projected to 
return to such levels.
    Thank you. I would be pleased to take your questions.

               RESPONSES TO WRITTEN QUESTIONS OF
             CHAIRMAN JOHNSON FROM BEN S. BERNANKE

Q.1. Before the House Financial Services Committee on February 
29th, in a response to Representative Velazquez, you said that 
``There are some reasons why lending has fallen, which no doubt 
will improve over time. But I think it's still the case that 
we're a little bit too far on this side of the--the pendulum 
has swung a little bit too far.'' To strengthen the economic 
recovery, I think it is important to find the right balance 
between safe and sound lending and making loans to credit 
worthy borrowers. What steps has the Fed taken to ensure the 
pendulum is swinging in the right direction? Is there anything 
else the Fed can do?

A.1. A critically important step taken by the Federal Reserve 
to support the economic recovery and improve the pace of 
lending has been to ease the stance of monetary policy. The 
easing has taken three main forms: First, we aggressively 
reduced the interest rate that we traditionally have relied on 
as our main policy tool. Since late 2008, that rate--known as 
the Federal funds rate--has been essentially at its zero lower 
bound. Second, we have provided participants in financial 
markets much greater clarity about where we see the Federal 
funds going in the future. In the statement released after its 
September meeting, the Federal Open Market Committee stated 
that ``exceptionally low levels for the Federal funds rate are 
likely to be warranted at least through mid-2015.'' Third, we 
have purchased longer-term Treasury and agency securities, with 
the goal of bringing down longer-term interest rates and 
improving conditions in markets in which many households and 
businesses borrow, including mortgage markets. In our judgment, 
these steps have caused financial and economic conditions to be 
much better than they otherwise would have been.
    The Federal Reserve has also taken several actions using 
its supervisory authority to promote lending to creditworthy 
households and businesses:

    In conjunction with other Federal banking 
        regulators, we issued interagency policy statements to 
        reinforce our position that, while maintaining 
        appropriately prudent standards, lenders should do all 
        they can to meet the legitimate needs of creditworthy 
        borrowers (Interagency Statement on Meeting the Needs 
        of Creditworthy Borrowers, November 12, 2008; 
        Interagency Statement on Meeting the Credit Needs of 
        Creditworthy Small Business Borrowers, February 5, 
        2010). We also issued guidance that encourages banks to 
        work constructively with borrowers experiencing 
        financial distress and provides specific examples of 
        ways in which banks can prudently restructure 
        commercial real estate transactions to the benefit of 
        both banks and their borrowers (Supervision and 
        Regulation Letter 09-4, ``Prudent Commercial Real 
        Estate Loan Workouts,'' October 30, 2009).

    To support these statements, we have held training 
        sessions for lenders in order to promote awareness 
        about both the credit environment and available lending 
        guidance and resources (Addressing the Financing Needs 
        of Small Businesses, July 12, 2010). And we have 
        continued to train bank examiners to use a balanced 
        approach to reviewing banks' credit policies and 
        practices with respect to lending.

    Along with the other Federal banking agencies, the 
        Federal Reserve assisted the Treasury Department in 
        implementing its Small Business Lending Fund program 
        (SBLF), which was established by the Small Business 
        Jobs Act of 2010. The SBLF is intended to facilitate 
        new lending to creditworthy small business borrowers by 
        providing affordable capital support to community 
        banks.

    We have also looked into specific concerns raised 
        about the examination process and its effect on banks' 
        willingness to lend. For example, during 2011, we 
        reviewed commercial real estate loan classification 
        practices to assess whether examiners were properly 
        implementing the interagency policy statement on 
        workouts of commercial real estate loans. We analyzed 
        documentation for more than 300 loans with identified 
        weaknesses in six Federal Reserve Districts. We found 
        that Federal Reserve examiners were appropriately 
        implementing the guidance and were consistently taking 
        a balanced approach in determining loan 
        classifications. Moreover, the documentation we 
        reviewed indicated that examiners were carefully 
        considering the full range of information provided by 
        bankers, including relevant mitigating factors, in 
        determining the regulatory treatment for the loans. 
        More recently, we investigated reports from some banks 
        that examiners were inappropriately criticizing 
        performing commercial loans. We found no evidence that 
        Federal Reserve examiners were deviating from well-
        established supervisory practices and rules for 
        classifying commercial loans.

    During 2012, we issued guidance to examiners 
        stressing the importance of promptly upgrading a bank's 
        supervisory rating when warranted by a sustainable 
        improvement in its condition and risk management 
        (Supervision and Regulation Letter 12-4, ``Upgrades of 
        Supervisory Ratings for Banking Organizations with $10 
        Billion or Less in Total Assets,'' March 1, 2012); Some 
        analysis has indicated that, all else being equal, 
        banks with lower supervisory ratings tend to lend less; 
        prompt upgrades by supervisors when such upgrades are 
        appropriate may thus ease an unnecessary constraint on 
        lending.

    The Federal Reserve continues to evaluate options to 
improve credit conditions and is committed to taking additional 
steps as needed to facilitate a balanced lending climate that 
ensures access to loans for credit worthy borrowers.

Q.2. I have heard some concerns about the liquidity coverage 
ratios promulgated under the Basel III Committee and 
specifically the exclusion of agency debt from Level 1 assets. 
Some suggest that this might encourage U.S. financial 
institutions to bulk-up on Treasuries and cash. Also, there are 
concerns that small financial institutions will have to hold 
and buy Treasuries at much higher levels than they currently 
do, further impacting their ability to lend. What do you think 
about these concerns? And would this exclusion put U.S. 
institutions at a disadvantage to their European counterparts?

A.2. The Board, in conjunction with the other U.S. Federal 
banking agencies, anticipates undertaking a domestic rulemaking 
in the United States based on the international liquidity 
standards established by the Basel Committee on Banking 
Supervision (BCBS) in 2010 (Basel III liquidity framework). The 
Basel III liquidity framework, like BCBS capital standards, 
applies to ``internationally active'' institutions. In the 
U.S., these are banking organizations with $250 billion or more 
in consolidated assets or $10 billion or more in foreign 
exposure. The Board has not determined that it is appropriate 
to apply the Basel III liquidity framework to community banking 
organizations.
    The Board, along with the other U.S. Federal banking 
agencies, carefully considers the appropriate scope of 
application when implementing any Basel standard or other 
prudential standard in the United States, including the impact 
of such standard on institutions of various sizes and 
complexity. In addition, the particular characteristics of U.S. 
markets and the U.S. banking system and the impact of new 
prudential standards on relevant markets, including competitive 
factors, are important concerns the Board takes into account 
when developing a rulemaking. In this respect, the Board would 
carefully consider the appropriate categorization of assets 
when implementing the Basel III liquidity framework.
    Any proposal the Board puts forth to implement the Basel 
III liquidity standards would be subject to a notice and 
comment process. We will carefully consider your comments and 
any others we receive regarding these proposals.

Q.3. As regulators implement the Wall Street Reform Act--which 
I believe is critical to returning our economy to sustainable 
growth--I've heard a wide range of concerns about the proposed 
Volcker Rule. Specifically, once the rule is finalized, which 
agency will take the lead to interpret, supervise, and 
ultimately enforce the final rule?

A.3. Section 619(b)(2) of the Dodd-Frank Act itself divides 
authority for developing and adopting regulations to implement 
its prohibitions and restrictions between the Federal Reserve, 
the OCC, FDIC, SEC, and CFTC based on the type of entities for 
which each agency is explicitly charged or is the primary 
financial regulatory agency. The statute also requires these 
agencies, in developing and issuing implementing rules, to 
consult and coordinate with each other for the purposes of 
assuring that such rules are comparable and to provide for 
consistent application and implementation. Under the statutory 
framework, the CFTC is the primary Federal regulatory agency 
with respect to a swap dealer and the SEC is the primary 
financial regulatory agency with respect to a security-based 
swap dealer; the Federal Reserve is explicitly charged with 
issuing regulations with respect to companies that control an 
insured depository institution, including bank holding 
companies. The OCC, Federal Reserve, and FDIC must jointly 
issue rules to implement section 619 with respect to insured 
depository institutions.
    To enhance uniformity in both rules that implement section 
619 and administration of the requirements of section 619, the 
Federal Reserve, OCC, FDIC, SEC, and CFTC have been regularly 
consulting with each other in the development of rules and 
policies that implement section 619. The rule proposed by the 
agencies to implement section 619 contemplates that firms will 
develop and adopt a single, enterprise-wide compliance program 
and that the agencies would strive for uniform enforcement of 
section 619.
                                ------                                


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

Q.1. There has been some speculation in the press about the 
Federal Reserve and OCC's thoughts on whether borrowers should 
be required to waive their legal rights as a condition of 
compensation under the foreclosure review being conducted under 
the consent orders.
    Does the Federal Reserve agree that homeowners should not 
be required to waive their legal rights in order to receive 
relief under the consent order process? Does the OCC agree with 
you on this issue?

A.1. The Board and OCC publicly stated their position on 
waivers in guidance issued by the agencies on June 21, 2012. In 
that guidance, the agencies stated that servicers may not ask 
borrowers to release any claims in order to receive remediation 
payments under the consent orders issued by the agencies. The 
guidance can be found on the Board's Web site at http://
www.federalreserve.gov/newsevents/press/bcreg/bcreg20 
120621b1.pdf, item 34.

Q.2. During the past year or so, while the private sector has 
added about 2 million jobs, state and local governments 
continue to shed jobs. One estimate says that there have been 
500,000 public sector job losses since the start of the 
recession.
    First, Chairman Bernanke, are you concerned about the level 
of public sector job losses, and can you comment on their 
effect on our economic recovery? Do you see a continued loss of 
public sector jobs to be a downside risk in our economic 
recovery?
    From the Federal fiscal policy perspective, is there 
anything Congress can be doing to mitigate against these public 
sector job losses?

A.2. The recent recession and the relatively sluggish pace of 
the subsequent recovery have placed significant fiscal strains 
on state and local governments. State and local tax revenues 
declined in the wake of the recession, and revenue gains since 
then have been relatively moderate, reflecting the slow 
recovery. As a result, state and local government spending has 
been under intense pressure. In particular, State and local 
governments have reduced the number of their employees by about 
500,000 since the beginning of the recession, which represents 
2\1/2\ percent of their workforce. (By comparison, private-
sector employment remains around 4 million- or 3\3/4\ percent-
below its level at the start of the recession, even though 
there have been private job gains since early 2010.) The 
decline in state and local employment has contributed 
importantly to the overall contraction in purchases of goods 
and services by these governments over the past 2\1/2\ years, 
which has been a notable headwind for the economy as a whole. 
For example, the decline in inflation-adjusted state and local 
purchases subtracted \1/4\ percentage point, on average, from 
the rate of real GDP growth over the past four quarters. As the 
pace of the economic recovery picks up and state and local 
finances continue to improve, net hiring by these governments 
is anticipated to eventually turn positive.
    The most helpful thing that the Congress could do to 
improve the fiscal conditions of State and local governments 
would be to help ensure that the economic recovery becomes 
stronger. As I have stated on many occasions, the primary task 
for Federal fiscal policymakers should be to put in place a 
credible medium-term budget plan that would put fiscal policy 
on a sustainable trajectory while also avoiding undue risk to 
the pace of the recovery in the near term. Doing so earlier 
rather than later would assist the current recovery by reducing 
uncertainty, holding down long-term interest rates, and 
maintaining the U.S. government's credibility in financial 
markets.

Q.3. Since your last testimony on the economy, oil prices have 
spiked, rising about 15 percent.
    I'm curious to probe what you think the causes are of this 
increase in oil prices. To what extent are the price increases 
due to tensions with Iran or instability in Europe? And to what 
extent are prices rising simply because people hope that the 
economy is recovering, and therefore oil demand might increase? 
Finally, to what extent do speculators continue to drive up the 
price of oil?
    Does the increase in oil prices at all change the Fed's 
view that inflation will remain at or below your 2 percent goal 
over the medium term?

A.3. Oil prices have been volatile since the beginning of the 
year with the spot price of Brent crude oil, a widely regarded 
benchmark for global oil prices, exhibiting a long swing up 
over the first 3 months of the year only to fall back sharply 
moving into the early summer. In recent weeks, oil prices have 
turned up once again and have recently returned to a level 
close to that which prevailed late last year. Along with other 
developments, we think that both geopolitical risk and 
uncertainty regarding the prospects for global growth--owing, 
in part, to developments in Europe--likely played a significant 
role in shaping oil price dynamics over this period.
    The Brent spot price averaged just under $110 per barrel in 
December of last year, supported by the loss of a significant 
amount of production due to the civil war in Libya. Rising 
geopolitical tensions stemming from the announcement of a new 
round of sanctions on Iran pushed oil prices steadily higher 
over the first three months of this year, with the spot price 
of Brent rising to an average of just under $125 per barrel in 
March. However, beginning in late March the intensification of 
the European debt crisis as well as data pointing to a slowdown 
in growth in both China and the United States began to raise 
concerns regarding the strength of global growth. Moreover, 
geopolitical tensions eased owing to increased diplomacy with 
Iran, while near-record high production from Saudi Arabia 
helped to assuage concerns regarding the ability of producers 
to offset any Iranian production lost as a result of the 
sanctions. Spot Brent prices subsequently declined over the 
next 3 months to touch just over $95 per barrel in June. 
Tensions with Iran have ratcheted up in recent weeks, and the 
geopolitical risk premium appears to have pushed spot Brent 
prices back up to the $110 per barrel range that prevailed late 
last year.
    There is little compelling evidence to support the claim 
that speculators were a significant factor in driving up the 
oil price early this year. If speculation drove oil prices well 
above levels consistent with physical supply and demand, then 
we would have expected inventories to rise as high prices both 
encouraged additional production and, at the same time, 
discouraged consumption. In fact, available measures of crude 
oil inventories were low relative to historic norms earlier 
this year and remained at relatively low levels until only 
recently. This was particularly true in both Europe and Asia, 
where crude oil inventories only slowly recovered from the loss 
of Libyan oil production last summer. In contrast, crude oil 
inventories have been elevated in the United States, 
particularly in Cushing Oklahoma, the delivery point for the 
benchmark West Texas Intermediate (WTI) contract. However, 
rather than speculation the buildup of inventories at Cushing 
likely reflects a rapid increase in crude oil supply in the 
Midwest, particularly from North Dakota, and the lack of 
sufficient infrastructure to integrate the region with the GUlf 
Coast and global markets. A consequence of the increase in 
inventories in the Midwest has been the emergence of a large 
price discount for WTI relative to similar grades of crude oil.
    The recent run up in oil prices is likely to be largely 
temporary. This view is supported by the oil futures curves, 
which are currently downward sloping, suggesting that financial 
market participants expect oil prices to decline. To the degree 
that an increase in oil prices is temporary in nature, it has a 
muted impact on underlying core inflation. As such, despite the 
run up in oil prices, our view that inflation will remain at or 
below 2 percent over the medium term is not materially altered. 
That said, going forward we will continue to closely monitor 
developments in commodity markets and the Fed stands ready to 
act if broader inflationary pressures materialize.

Q.4. Last September you called the unemployment situation a 
``national crisis,'' noting in particular the plight of the 
long-term unemployed. You said ``This has never happened in the 
post-war period in the United States. They [the long-term 
unemployed] are losing the skills they had, they are losing 
their connections, their attachment to the labor force.''
    In light of recent studies that show America falling behind 
in our commitment to providing workers the opportunities to 
train for skills needed in the 21st century economy, can you 
comment on your view of the magnitude of this challenge for the 
long-term unemployed?
    Do you believe that business focused training, that is 
partnerships between businesses and colleges where unemployed 
and underemployed are provided the opportunity to train in the 
skills needed by employers in the region, can be an effective 
way to meet this challenge both for our current recovery and 
America's long-term competitiveness?

A.4. Long-term unemployment presents a serious challenge. 
Unemployment creates enormous financial hardship for families, 
and workers who lose their jobs and remain unemployed for some 
time often experience sharp declines in earnings that may last 
for many years, even after they find new work. There is 
evidence that unemployment takes a toll on people's health as 
well. And unemployment strains public finances because of both 
lost tax revenue and the payment of unemployment benefits and 
other types of income support. The high rates of unemployment 
and long-term unemployment, and the prospect that these could 
remain elevated for some time, are important reasons why the 
Federal Reserve has pursued a highly accommodative monetary 
policy over the past several years.
    People unemployed for a long time have historically found 
jobs less easily than those experiencing shorter spells of 
unemployment, perhaps because their skills erode, they lose 
relationships within the workforce, or they acquire a stigma 
that deters firms from hiring them. I have frequently spoken 
about the importance of life-long learning, including 
continuing education for adults, and well-designed programs to 
assist the unemployed can play a valuable role in that regard. 
In particular, many in the business and academic communities 
believe that business-focused training, of the sort you 
describe, has been effective in many cases where it has been 
tried. Such approaches may be a fruitful avenue to explore, in 
concert with general improvements in our educational system and 
broader actions to address our current macroeconomic situation.

Q.5. Safeguarding the U.S. financial systems from proliferation 
financing, terror financing, money laundering and other 
criminal acts is crucial to the long term health of the U.S. 
economy and the security of our Nation. I believe the Federal 
Reserve has a central role in ensuring all U.S. based financial 
institutions maintain robust risk management and compliance 
programs to address these threats.
    Can you describe the efforts of the Federal Reserve to 
ensure the U.S. financial system is not abused to aid the 
financing of terrorism and weapons proliferation, and money 
laundering, particularly when it comes to Iran?

A.5. The Federal Reserve, in coordination with the Department 
of the Treasury and the other U.S. Federal financial regulatory 
agencies, seeks to ensure that financial institutions maintain 
appropriate risk management and compliance programs related to 
money laundering, financing of terrorism, and sanctions 
administered by the Office of Foreign Assets Control (OFAC), 
including the extensive sanctions against Iran.
    While the Department of the Treasury maintains primary 
responsibility for issuing and enforcing regulations to 
implement the Bank Secrecy Act (BSA), the comprehensive Federal 
antimoney laundering (AML) and counter-terrorism financing 
(CFT) statute, it has delegated to the Federal banking agencies 
responsibility for monitoring banks' compliance with the BSA. 
During bank examinations, Federal Reserve examiners review and 
assess an institution's compliance with relevant BSA and OFAC 
sanctions requirements, following a risk-based approach.
    The Federal Reserve has coordinated extensively with OFAC 
on its efforts under the Comprehensive Iran Sanctions, 
Accountability, and Divestment Act of 2010 (CISADA). This law 
builds upon the U.S. Government's role in protecting its 
domestic financial system from exposure to Iran's illicit and 
deceptive financial practices by strengthening existing U.S. 
sanctions. The Federal Reserve regularly shares examination 
findings and enforcement proceedings with OFAC under the 2006 
interagency memorandum of understanding.
    The Federal Reserve actively participates in a number of 
coordination initiatives related to money laundering, terrorism 
financing, and sanctions. These include the Treasury-led BSA 
Advisory Group, which includes representatives of regulatory 
agencies, law enforcement, and the financial services industry 
and the FFIEC BSA/ AML working group, a monthly forum for the 
discussion of pending BSA policy and regulatory matters. In 
addition to the Federal banking agencies, the BSA/AML working 
group includes FinCEN and, on a quarterly basis, the Securities 
and Exchange Commission, the Commodity Futures Trading 
Commission, the Internal Revenue Service, and OFAC in order to 
share and discuss information on policy issues and general 
trends more broadly.
    In the international context, the Federal Reserve is a 
member of the U.S. delegation to the intergovernmental 
Financial Action Task Force (FATF) and its working groups, 
contributing a banking supervisory perspective to the 
formulation of international standards on these matters. 
Recently, the Federal Reserve provided input and review of 
ongoing work to revise the FATF Recommendations in order to 
ensure that they continue to provide a comprehensive and 
current framework for combating money laundering and terrorist 
financing. The Federal Reserve also participates in ongoing 
work of the Basel Committee that focuses on AML/
counterterrorism financing issues.

Q.6. A few months ago, I met with many of the OMWI directors at 
the Federal Reserve about the steps you are taking on 
diversity, particularly in the procurement area. I was not 
particularly happy with the meeting, as I did not feel that 
sufficient progress was being made when it comes to contracting 
with Hispanic-owned businesses. One of the responses we heard 
echoed by the Directors was that Hispanic diversity has been an 
ongoing challenge, although I was not able to get specifics.
    Therefore, I am asking now what barriers you have 
identified for women- and minority-owned firms to compete. What 
barriers are unique to Hispanic-owned firms? What are you doing 
to overcome those barriers?

A.6. What barriers have been identified for women- and 
minority-owned firms to compete?
    The following challenges have been identified:

    Lack of knowledge by businesses on how to do 
        business with the Federal Reserve Board

    Lack of knowledge by businesses on the goods and 
        services procured by the Board

    Ability to identify and track women- and minority-
        owned businesses and the products and services they 
        offer in order to match to the products and services 
        contracted by the Board

    Lack of networking opportunities between prime 
        contractors and women- and minority-owned firms 
        interested in subcontracting opportunities

    What barriers are unique to Hispanic-owned firms?

    There are no unique barriers and/or challenges for 
Hispanic-owned firms to compete in relation to those identified 
for women- and minority-owned firms.

    What is being done to overcome barriers?

    The Board has hired a Supplier Diversity Specialist to 
focus on the inclusion of minority- and women-owned businesses 
in the business practices of the Board. A public Web site is 
also being developed that will enable companies to register, 
identify their business classification, and include information 
regarding their products and services. The Web site will also 
enable the Board to search for companies that provide goods or 
services called for in specific solicitations. The Web site is 
in final testing and is projected to be available the fourth 
quarter of 2012.
    The Board has instituted a number of initiatives to 
communicate how to do business with the Board. For example, the 
Board continues to host an annual business fair to attract 
diverse pools of vendors. These annual fairs provide an 
opportunity for businesses that provide the products and 
services the Board procures to discuss their companies with 
specific Board purchasing departments. Participants also attend 
a workshop on how to compete for business contracts at the 
Board. The most recent business fair, held in May 2012, 
included information about the projected Board's 2012-2013 
acquisition forecast. In April 2012, the Board hosted a 
business forum for minority- and women-owned firms which 
provided information on building business capacity to compete 
for Federal contracts. This forum is projected to be yearly. 
The Supplier Diversity Specialist also meets with prospective 
suppliers to prequalify and offer technical assistance to 
minority- and women-owned businesses that are interested in 
and/or responding to open solicitations. The Board continues to 
operate under its Small Disadvantaged Business Acquisition 
policy, consistent with applicable law, to ensure small and 
socially and economically disadvantaged businesses have an 
equitable opportunity to compete in the Board's procurement 
activities. The Boards general contract provisions include 
standard language that requires contractors to confirm their 
commitment to ensuring fair inclusion of women and minorities 
in employment and contracting. During the contract solicitation 
phase, prospective vendors can submit a subcontracting plan 
with their proposal that supports this requirement.
    The Board's external strategies focus on developing 
partnerships with minority- and women-owned business advocacy, 
community and industry groups to further cultivate 
relationships. We are applying for membership in local and 
national associations focusing on minority- and women-owned 
business such as Women Business Enterprise National Council 
(WBENC), National Minority Supplier Development Council 
(NMSDC), and the Greater Washington Hispanic Chamber of 
Commerce (GWHCC). The Board has significantly strengthened its 
relationship with Hispanic advocacy groups, by forging 
relationships through collaboration. The Board regularly 
submits pertinent information regarding upcoming solicitations 
to the GWHCC for their members to participate in the Board's 
acquisition process. We also participated in the GWHCC Business 
Expo to meet with Hispanic firms to discuss future 
opportunities as well. Through our partnership with the GWHCC, 
we have identified over 20 Hispanic firms to participate in our 
2012-2013 acquisition process. The Board also exhibits at 
various conferences to promote our contracting opportunities. 
We continue to participate at the national business conferences 
such as National 8 (a) Association Conference, WBENC, NMSDC, 
and continue to work with chambers of commerce including the 
U.S. Hispanic Chamber of Commerce. The Board's Procurement 
staff met with Hispanic firms during the U.S. Hispanic Chamber 
of Commerce Legislative Summit to discuss their capabilities 
both for current and future acquisitions.
    The OMWI Director also has participated on panels at 
conferences discussing minority-and women-owned firms doing 
business with the Federal government which included the 2011 
Minority Economic Conference hosted by the Florida Minority 
Community Reinvestment Coalition.
    The Board has had a continued commitment to the inclusion 
of minority- and women-owned businesses in its procurement 
practices. The OMWI and Procurement offices, which have the 
primary responsibility for ensuring current and proposed 
policies and practices affecting inclusion of minority- and 
women-owned businesses, will meet on a regular basis to assess 
results of supplier diversity objectives and activities and to 
determine whether additional efforts would be helpful in 
assisting minority- and women-owned firms to compete 
successfully in the Board's acquisition process.
                                ------                                


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

Q.1. Section 1: Chairman Bernanke, in your testimony you noted 
that in September of last year the Federal Open Market 
Committee determined that it would reinvest principal received 
from holdings of agency MBS and agency debt in agency MBS.
    What is the impact of a dollar of principal that is 
reinvested in a Treasury security relative to a dollar of 
principal invested in agency MBS?

A.1. The Federal Reserve's purchases of longer-term assets are 
intended to put downward pressure on longer-term interest rates 
and ease financial conditions more generally. The effect of a 
dollar invested in a Treasury security relative to a dollar 
invested in an agency MBS depends on many factors, including 
the remaining maturity of the securities. In general, longer-
term securities would be thought to have a somewhat more 
powerful effect. Both Treasury securities and agency MBS 
purchases have the effect of easing broad financial conditions 
and putting downward pressure on longer-term interest rates. In 
principle, MBS purchases should also improve conditions in 
mortgage markets and so help support the housing sector and 
thereby contribute to a stronger economic recovery.

Q.2. Is reinvested principal going into new or seasoned or new 
issues of Agency MBS?

A.2. The Open Market Desk (the Desk) at the Federal Reserve 
Bank of New York purchases agency MBS that are concentrated in 
newly-issued agency MBS in the To-Be-Announced market, although 
the Desk may purchase other fixed-rate agency MBS securities 
guaranteed by Fannie Mae, Freddie Mac, and Ginnie Mae if market 
conditions warrant. The eligible assets include, but are not 
limited to, 30-year and 15-year securities of these issuers. A 
summary of agency MBS purchases is reported on the Federal 
Reserve Bank of New York's (http://www.newyorkfed.org/markets/
ambs).
    Additional information on the Desk's agency MBS purchases 
can be found at the following link: http://www.newyorkfed.org/
markets/ambs/ambs_faq.html.

Q.3. As borrowers take advantage of historically low rates to 
refinance, is the Fed seeing an acceleration in principal 
payments?

A.3. Principal payments of agency mortgage-backed securities 
(MBS) tend to increase when mortgage rates decline. Since the 
summer of 2011, mortgage rates have fallen to very low levels 
and principal payments have increased. The Federal Reserve has 
seen an acceleration in principal payments on its agency MBS 
holdings, with principal payments averaging about $25 billion 
per month since October 2011, roughly double the level seen 
during the summer of 2011. A number of other factors also 
influence the speed of principal payments. Currently, tight 
underwriting standards and low levels of housing equity are 
likely damping mortgage refinancing activity and, hence, 
holding down prepayments.

Q.4. Section 2: Section 619 of the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (Dodd-Frank) seeks to 
prohibit federally insured depository institutions and their 
affiliates from engaging in short-term proprietary trading and 
to limit certain relationships with hedge funds and private 
equity funds.
    Specifically, Section 619 added a new Section 13 to the 
Bank Holding Company Act of 1956 (BHC Act), that prohibits a 
``banking entity'' from acquiring or retaining an ownership 
interest in or sponsoring a ``hedge fund'' or ``private equity 
fund,'' subject to certain exceptions.
    I want to applaud the Federal Reserve, with its expertise 
as the primary regulator of bank holding companies, for 
acknowledging the importance of traditional asset management 
services and for attempting to propose a rule that does not 
unduly constrain the ability of U.S. banking entities to 
provide those services.
    It is clear from the statute and the congressional record 
that Congress intended to cover only those funds that ``engage 
in activities or have characteristics of a traditional private 
equity fund or hedge fund.''
    Generally speaking, does the Federal Reserve see non-U.S. 
funds that are publicly offered by U.S. banking entities as 
posing the same risks as traditional hedge funds and private 
equity funds?

A.4. The joint proposal issued by the Federal Reserve, OCC, 
FDIC, and SEC requested comment on a wide variety of issues, 
including regarding how section 619 applies to non-U.S. funds, 
as well as the scope of the statutory exemption for certain 
hedge fund and private equity fund activity and investment that 
occurs ``solely outside of the United States.'' See 12 U.S.C. 
1851(d)(l)(l). The agencies' proposal invited comment on 
whether non-U.S. funds posed the same risks to U.S. banking 
entities as U.S. funds. The agencies received a significant 
amount of comment on the joint proposal and the Federal Reserve 
is carefully reviewing and considering these comments as we 
work to finalize implementing rules.

Q.5. Would the Federal Reserve be willing to work to craft a 
``covered fund'' definition that would treat analogous U.S. and 
non-U.S. funds similarly, as was the intent of the statute?

A.5. The joint proposal issued by the Federal Reserve, OCC, 
FDIC, and SEC applies to activities by U.S. banking entities 
involving non-U.S. funds in the same way it applies to 
activities by those entities in U.S. funds to the extent that 
the non-U.S. fund would be covered by the statute were it a 
U.S. fund. The joint agency proposal also invited public 
comment on whether the proposed rule effectively and correctly 
implemented the statutory definition of hedge fund and private 
equity fund and treatment of non-U.S. funds for purposes of 
section 619. The agencies received a significant amount of 
comment on the joint proposal and the Federal Reserve is 
carefully reviewing and considering these comments as we work 
to finalize implementing rules.
                                ------                                


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

Q.1. Following up on your Volcker comments, I agree with you 
that ``we certainly don't expect people to obey a rule that 
doesn't exist'' and welcome your comment that the Agencies 
``will certainly make sure that firms have all the time they 
need to respond.'' And yet, while Dodd-Frank provides a two-
year conformance period, the preamble to the proposed rule 
states that the Agencies expect full compliance ``as soon as 
practicable'' after the effective date (July 21, 2012). In 
addition, commenters are concerned that the proposed rule would 
effectively require firms to have sophisticated reporting and 
recordkeeping systems and procedures in place on the effective 
date, notwithstanding the 2-year conformance period. This is 
because, as drafted, the proposed rule conditions the 
availability of key statutory exemptions (e.g., market making 
and hedging) on the existence of these systems and procedures. 
How do you intend to resolve this discrepancy?

A.1. Section 619 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dodd-Frank Act) required the Federal 
Reserve to adopt rules governing the conformance periods for 
activities and investments restricted by section 619, which the 
Federal Reserve did on February 9, 2011 (Conformance Rule). In 
its Conformance Rule, the Federal Reserve explained that it 
would revisit the conformance period rule, as necessary, in 
light of the requirements of the final rule implementing the 
substantive provisions of the Volcker Rule. Subsequently, the 
Federal Reserve received a number of requests for clarification 
of the manner in which this conformance period would apply and 
how the prohibitions would be enforced. On April 19, 2012, the 
Federal Reserve issued a statement clarifying that an entity 
covered by section 619 has the full 2-year period provided by 
statute to fully conform its activities and investments to the 
requirements of section 619 and any implementing rules adopted 
in final under that section, unless the Board extends that 
conformance period. The other agencies charged with enforcing 
section 619 simultaneously announced that they would enforce 
section 619 in accordance with the Federal Reserve's statements 
regarding the conformance period.
    Additionally, the Federal Reserve, the OCC, the FDIC, SEC, 
and CFTC have proposed rules to implement section 619; as part 
of those proposals, the agencies met with many interested 
representatives of the public, including banking firms, trade 
associations and consumer advocates, and provided an extended 
period of time for the public to submit comments to the 
agencies. The agencies have received over 19,000 comments 
addressing a wide variety of aspects of the proposal, including 
the exemptions for market making-related activities, risk-
mitigating hedging activities, the use of metrics, and the 
reporting proposals. The agencies are carefully reviewing those 
comments and considering the suggestions and issues they raise 
in light of the statutory restrictions and provisions. We will 
carefully consider the issues you note as we continue to review 
all comments submitted in crafting a final rule to implement 
section 619.
                                ------                                


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

Q.1. Chairman Bernanke, I would like to ask you about the 
Federal Reserve's supervisory authority over thrift holding 
companies, which is new authority granted to the Federal 
Reserve as part of the Dodd-Frank Act. Some of these thrift 
holding companies are, or own, life insurers. It is my 
understanding that the Federal Reserve, in exercising this new 
authority, has placed supervisors on site at some of these 
thrift holding companies.
    Can you discuss the Fed's efforts to supervise thrift 
holding companies as well as what the Fed is doing to increase 
its expertise and knowledge base with regard to insurers?

A.1. As of December 31, 2011, there were 417 top tier Savings 
and Loan Holding Companies (SLHCs) with estimated total 
consolidated assets of $3 trillion. These SLHCs include 
approximately 48 companies engaged primarily in nonbanking 
activities, such as insurance underwriting (approximately 26 
SLHCs), commercial activities (approximately 11 SLHCs), and 
securities brokerage (11 SLHCs). Since the transfer of SLHC 
supervision to the Federal Reserve on July 21, 2011, 114 SLHCs 
have been issued indicative ratings, \1\ 50 discovery reviews 
\2\ have been completed, and an additional 34 discovery 
reviews, 27 inspections and 21 offsite reviews have been 
initiated.
---------------------------------------------------------------------------
     \1\ An ``indicative rating'' indicates to the SLHC how it would be 
rated if the RFI rating system was formally applied.
     \2\ A discovery review is an inspection activity designed to 
improve the Federal Reserve's understanding of a particular business 
activity or control process.
---------------------------------------------------------------------------
    A dedicated SLHC section in the Board's Division of Banking 
Supervision and Regulation has been staffed and is working to 
continue the supervisory and policy oversight of the SLHCs. 
Regarding the 26 SLHCs that are primarily engaged in insurance 
activities, the Federal Reserve is using the first cycle of 
SLHC inspections to learn more about the particular operations 
of each insurance SLHC (ISLHC), as explained in SR letter 11-11 
(July 21, 2011) \3\ Supervisory assessments are currently being 
conducted at each ISLHC and its subsidiaries to more fully 
understand the activity make up of each ISLHC and to determine 
if any activities pose safety and soundness concerns. The 
Board's consolidated supervisory program is applied to ISLHCs 
in a risk-focused manner and supervisory activities (such as, 
continuous monitoring, discovery reviews, and testing) vary 
across the portfolios of institutions based on size, 
complexity, and risk. Board and Reserve Bank staffs are working 
to create supervisory plans that address the risks associated 
with the activities of ISLHCs. For example, pilot ISLHC 
inspection procedures have been developed and are currently 
being used by examiners in the inspection of ISLHCs. Staff will 
revise and finalize these procedures based on feedback received 
from examiners.
---------------------------------------------------------------------------
     \3\ SR letter 11-11, ``Supervision of Savings and Loan Holding 
Companies'' (July 21, 2011), describes the supervisory approach to be 
used for the first cycle of supervision of SLHCs 
(www.federalreserve.gov/bankinforeg/srletters/sr1111.htm).
---------------------------------------------------------------------------
    To foster consistency and assist examiners in developing 
their knowledge of the unique aspects of ISLHCs, the following 
activities also have been instituted:

    Four conferences for Board and Reserve Bank staff 
        supervising ISLHCs have been held since the transfer of 
        SLHC supervision to the Federal Reserve. (August 2012, 
        D.C.; June .2012, D.C.; November 2011, D.C.; and August 
        2011, Chicago).

    Ongoing System-wide calls are held and have 
        included training sessions conducted by outside vendors 
        on insurance related issues and discussions on ISLHC 
        supervision. Participants include Reserve Bank and 
        Board staff. Internal insurance training courses also 
        are under development.

    Regular communication with the National Association 
        of Insurance Commissioners (NAIC) \4\ along with 
        Reserve Bank and Board attendance at NAIC conferences.
---------------------------------------------------------------------------
     \4\ NAIC is an organization formed by State insurance regulators 
and has no regulatory authority.

    Regular communication with the Federal Insurance 
---------------------------------------------------------------------------
        Office and the Financial Stability Oversight Council.

Q.2. Previously, when asked, Mr. Volcker was unable to give a 
clear definition of ``proprietary trading'' but essentially 
said that he knew it when he saw it.
    As the regulators draft the Volcker Rule, which is focused 
on proprietary trading, what is your definition of the term?
    Is this the exact definition used in the proposed rule?
    If not, how does the definition in the proposed rule 
differ?

A.2. Section 619 of the Dodd-Frank Wall Street Reform and 
Consumer Protection Act (Dodd-Frank Act) generally prohibits 
banking entities from engaging in proprietary trading. Section 
619(h)(4) of that Act defines ``proprietary trading'' to mean 
``engaging as principal for the trading account in any 
transaction to purchase or sell, or otherwise acquire or 
dispose of specified financial instruments. See 12 U.S.C. 
1851(h)(4). Another part of section 619 defines ``trading 
account'' as any account used to engage in proprietary trading 
for the purposes of profiting from short-term price movements. 
See 12 U.S.C. 1851(h)(6). The statute also provides a number of 
exemptions from the prohibition on proprietary trading, such as 
exemptions for market making-related activity or risk-
mitigating hedging activity. See U.S.C. 1851(d)(l)(B) and (C). 
The proposal to implement section 619 of the Dodd-Frank Act by 
the Federal Reserve, OCC, FDIC, SEC, and CFTC (the 
``Agencies'') requested public comment on a definition of 
``proprietary trading'' that restates the statutory definition.
    The Agencies received over 19,000 comments regarding the 
proposed implementing rules, including comments that 
specifically addressed the issues of proprietary trading and 
related definitions. The Agencies are currently considering 
these comments as we work to finalize implementing rules.

Q.3. Apparently, the definition of state and municipal 
securities in the Dodd-Frank Act does not conform with the 
earlier Securities Exchange Act definitions, subjecting these 
securities to the Volcker Rule.
    What will the additional costs be to State and local 
governments in issuing bonds?

A.3. Section 619(d)(l)(A) of the Dodd-Frank Act provides an 
exemption for proprietary trading in obligations of the United 
States or any agency thereof, obligations, participations, or 
other instruments of or issued by certain Government sponsored 
entities, and obligations of any State or of any political 
subdivision thereof. See 12 U.S.C. 1851(d)(l)(A). A number of 
Securities Exchange Act provisions apply to obligations and 
instruments of any agency of a State or political subdivision 
thereof, as well as to obligations of the State of a political 
subdivision itself. The Dodd-Frank Act, however, did not by its 
terms extend its exemption to proprietary trading in 
obligations of an agency of any State or political subdivision 
thereof. The Agencies proposed an exemption for municipal 
securities that mirrored the words of the Dodd-Frank Act. The 
Agencies also requested public comment on whether the exemption 
should be extended to include the broader definition of 
``municipal security'' used in the Securities Exchange Act.
    The Agencies received over 19,000 comments regarding the 
proposed implementing rules, including comments that 
specifically addressed the exemption for government obligations 
and the definition of municipal security. The Agencies are 
currently considering these comments as we work to finalize 
implementing rules.

Q.4. Do you believe that, as proposed, the Volcker Rule has the 
potential to raise the cost of capital for nonfinancial small 
and mid-size businesses?
    Has any analysis been performed on this issue in relation 
to the proposed Volcker Rule?
    Has any analysis been performed on the potential impact on 
access to capital for nonfinancial small- and mid-sized 
businesses that may be created by the confluence of the Volcker 
Rule, the implementation of Basel III, and the SEC's impending 
money market regulations?
    Will you please provide my office with copies of any such 
analysis or assessments?

A.4. As part of the proposed rules to implement section 619 of 
the Dodd-Frank Act, the Agencies proposed a multifaceted 
regulatory framework to implement the statute in accordance 
with its terms. In the proposal, the Agencies recognized that 
there are economic impacts that may arise from the proposed 
rule, and invited comments on potential economic impacts. The 
Agencies also encouraged commenters to provide quantitative 
information about the impact of the proposal not only on 
entities subject to section 619, but also their clients, 
customers, and counterparties, specific markets or asset 
classes, and any other entities potentially affected by the 
proposed rule, including nonfinancial small and mid-size 
businesses. The Agencies received over 19,000 comments 
regarding the proposed implementing rules, including comments 
regarding potential costs and benefits. The Agencies are 
currently considering these comments as we work to finalize 
implementing rules and will take account of the potential costs 
and benefits of any implementing rules as the agencies develop 
a final rule consistent with the requirements of the statute.
                                ------                                


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

Q.1. The unemployment rate's drop in recent months to 8.3 
percent may have overshadowed a troublesome trend, which is the 
fact fewer Americans are looking for work. For example, the 
latest jobs report showed that the share of working-age people 
in the labor force had declined to the lowest level in 29 
years. Furthermore, while unemployment has fallen 1.4 
percentage points over the past 24 months, the participation 
rate has dropped 1.1 percentage points. The share of Americans 
with jobs, known as the employment-to-population ratio, hasn't 
budged--posting the same number last month (58.5) as in January 
2010. This information combined with the fact we have seen 
record numbers of long-term unemployed is very concerning. 
Chairman Bernanke, is the recent trend of lower labor force 
participation a significant indicator of the strength of the 
U.S. economic recovery? Should U.S. policy makers be concerned 
about this trend?

A.1. Several factors account for the decline in labor force 
participation that we have seen. Part of the decline reflects 
longer-term demographics that are largely distinct from the 
weak economic situation. In particular, as the baby boom cohort 
ages, larger numbers of individuals have been reaching ages at 
which, typically, labor force participation is lower. But 
demographics probably cannot fully explain the relatively low 
participation rate that we have seen. The fact that the labor 
market remains weak, with relatively few jobs available, has 
likely led many individuals to remain out of the labor force. 
On the other hand, the loss of housing and stock-market wealth 
associated with the housing collapse and the recession no doubt 
induced many others to stay in the labor force for longer than 
they otherwise might have. Quantifying these various forces is 
difficult, but to the extent that the slowing in participation 
does reflect cyclical factors, then as the economy strengthens, 
participation may be expected to increase, or at least to 
decline by less than the underlying demographic trend would 
suggest.
    A downward trend in labor force participation that 
represents natural demographics may not be a cause for concern. 
However, there are some potentially concerning aspects to the 
decline. The effect of a declining workforce on public finances 
is one potential issue. Another concern stems from the large 
rise in disability rolls, and the possibility that part of that 
rise represents individuals who could and would work if more 
jobs were available. Moreover, participation rates for teens 
and young adults have declined. To some extent, this decline 
for young people reflects increased schooling, which is likely 
for the good; but if the lower participation implies that young 
people are not gaining valuable work experience, it would be a 
cause for concern.

Q.2. Chairman Bernanke, you noted in your testimony that the 
job market has seen some improvement but that ``continued 
improvement in the job market is likely to require stronger 
growth in final demand and production . . . The unemployment 
rate remains elevated, long-term unemployment is still near 
record levels, and the number of persons working part time for 
economic reasons is very high.'' What type of ``stronger 
growth'' is necessary to tackle the problem of anemic job 
creation?

A.2. In the latter part of 2011 and early this year, job growth 
picked up and the unemployment rate declined even though GDP 
was rising at only a modest rate. Normally, when GDP rises at 
its longer run ``potential'' rate associated with normal growth 
of the labor force and productivity, the unemployment rate will 
remain stable; a declining unemployment rate generally requires 
GDP to rise at a rate faster than potential. A number of 
factors might help account for the decline in the unemployment 
rate despite only modest GDP growth, but part of the story 
could be that last year's decline in unemployment represented a 
``catch up'' from the deepest part of the recession, when 
employers were cutting payrolls even more sharply than would 
have been predicted given the declines in demand that they were 
facing, perhaps because they feared that an even sharper 
contraction might be in the offing. Such a period of catch up 
eventually will come to an end, and indeed, since early this 
year the unemployment rate has been about flat at 8\1/4\ 
percent, while GDP growth has slowed only a little. Thus, to 
achieve further declines in unemployment, we will likely need 
to see GDP growth rising more rapidly than we have seen over 
the past year.

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