[Senate Hearing 112-723]
[From the U.S. Government Publishing Office]
S. Hrg. 112-723
FEDERAL RESERVE'S SECOND 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
__________
JULY 17, 2012
__________
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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
Marc Labonte, Detailed CRS Economist
Andrew Olmem, Republican Chief Counsel
Michael Piwowar, Republican Chief Economist
Dana Wade, Republican Professional Staff Member
Gregg Richards, Republican Professional Staff Member
Dawn Ratliff, Chief Clerk
Ryker Vermilye, Hearing Clerk
Shelvin Simmons, IT Director
Jim Crowell, Editor
(ii)
C O N T E N T S
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TUESDAY, JULY 17, 2012
Page
Opening statement of Chairman Johnson............................ 1
Opening statements, comments, or prepared statements of:
Senator Shelby
Prepared statement....................................... 42
Senator Crapo................................................ 2
WITNESS
Ben S. Bernanke, Chairman, Board of Governors of the Federal
Reserve System................................................. 4
Prepared statement........................................... 43
Responses to written questions of:
Chairman Johnson......................................... 46
Senator Reed............................................. 51
Senator Warner........................................... 52
Senator Merkley.......................................... 55
Senator Vitter........................................... 59
Senator Toomey........................................... 61
Senator Kirk............................................. 64
Additional Material Supplied for the Record
Monetary Policy Report to the Congress dated July 17, 2012....... 68
(iii)
FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2012
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TUESDAY, JULY 17, 2012
U.S. Senate,
Committee on Banking, Housing, and Urban Affairs,
Washington, DC.
The Committee met at 10:03 a.m., in room SD-G50, Dirksen
Senate Office Building, Hon. Tim Johnson, Chairman of the
Committee, presiding.
OPENING STATEMENT OF CHAIRMAN TIM JOHNSON
Chairman Johnson. I call the hearing to order. Today we
welcome Chairman Bernanke back to the Committee to deliver the
Federal Reserve's semiannual Monetary Policy Report.
The legacy of the financial crisis still weighs heavily on
our Nation's economy and financial system today. Following the
longest and deepest recession since the Great Depression, the
economy has grown slowly but steadily since 2009. We have come
a long way, but there is still a lot of work left to be done to
get our economy back to the point where jobs are readily
available and wages are rising for American workers.
While the economy is not growing as fast as we would like,
it is important to recognize that it would not be growing at
all if Congress and the Federal Reserve had not taken action to
restore financial stability.
The Wall Street Reform Act created a framework for a
financial system that is stable, works in the consumers'
interest, and never again allows bank bailouts. Recent events
such as CFTC ordering Barclays to pay a $200 million penalty
for LIBOR manipulation are reminders that we need tough, fair
rules in place and strong, adequately funded financial
regulators to enforce those rules.
Some critics say that the cost of financial regulation is
too high, but those same critics seek to underfund our
regulators and ignore the reality that today's high
unemployment and battered economy were caused by inadequate and
ineffective regulations. That is why we passed the Wall Street
Reform Act, and that is why we are safer today than before the
crisis.
Any cost that Wall Street bears from playing by the rules
pales in comparison to the trillions of dollars that Americans
lost as a result of the last financial crisis. As we recognize
the second anniversary of the Wall Street Reform Act, I look
forward to hearing from Chairman Bernanke on the Fed's progress
in carrying out its new responsibilities and how these efforts
have further stabilized the financial system.
Though policy makers can make the financial system more
stable and resilient to negative shocks to the economy, they
cannot prevent those shocks from occurring in the first place.
While recent policy actions taken in Europe are welcome, the
eurozone economy remains fragile. I would like to hear the
Chairman's thoughts on the progress that has been made in the
eurozone and how U.S. policy makers can protect our economy
from the potential fallout if the situation were to worsen.
While the Fed's role in the economy is important, we need
to acknowledge that the Fed cannot solve all of the economy's
problems. The housing market has been holding back the economy
for too long, and I ask this Committee to support efforts of my
colleagues to enact legislation to give responsible homeowners
the opportunity to refinance their mortgages. This legislation
is fair because it helps homeowners who have been playing by
the rules, is market-friendly because it eliminates barriers to
competition and is a cost-effective way to jump-start the
economy because it keeps more of workers' paychecks in their
pockets.
Congress also needs to reach a sensible resolution to the
fiscal cliff problem at the end of the year. I support the
President's plan to extend expiring tax cuts for the middle
class. Today's hearing underlines the importance of effective
oversight, which has been a leading priority of mine as
Chairman of the Committee. In the past 18 months, we have
conducted frequent oversight hearings with all of the financial
regulators. In the coming weeks, we will conduct oversight
hearings with Secretary Geithner, in his role as the head of
the Financial Stability Oversight Council, and with the
Director of the Consumer Financial Protection Bureau, Richard
Cordray.
I have welcomed the steps that Chairman Bernanke has taken
to make the Fed more transparent, including the decision to
release its communications with Barclays on LIBOR. I also
believe that the Wall Street Reform Act's enhancements to Fed
transparency and oversight have had a positive impact.
I now turn to Senator Crapo.
STATEMENT OF SENATOR MIKE CRAPO
Senator Crapo. Thank you very much, Chairman Johnson. I
appreciate your holding this hearing today. And, Chairman
Bernanke, we appreciate having you with us for your semiannual
Monetary Policy Report to Congress.
Senator Shelby is unable to attend today because of a
family obligation, but I ask that his statement be made a part
of the record and note that he will be submitting questions for
the record.
Chairman Johnson. Without objection.
Senator Crapo. Thank you, Mr. Chairman.
The U.S. economy continues to experience disappointing job
growth and faces significant challenges with the eurozone debt
crisis, the tax cliff, and our broader fiscal crisis, which
includes the need to address the impending insolvency of the
entitlement programs. A disappointing 80,000 jobs were added in
June, holding unemployment steady at 8.2 percent.
In June, Chairman Bernanke warned Congress about what could
happen if it does not address the so-called fiscal cliff,
noting that this would have a very significant impact on the
near-term recovery. According to CBO, if all of the tax and
spending measures under current law were to occur together, the
economy would grow at just 0.5 percent in 2013 compared to a
4.4 percent expectation absent these measures.
Recently, one of the largest private owners of U.S. debt
said that we have until 2016 to contain our borrowing before
bond investors revolt and drive up interest rates. Others
suggest the timetable could be much sooner.
The lack of economic growth has caused some to call for
further expansion of the Federal Reserve's $2.9 trillion
balance sheet through a third round of so-called quantitative
easing. However, there are a lot of questions about how
effective the first two rounds of quantitative easing have
been, what their long-term impacts will be, and how effective
an additional round of quantitative easing could be. I am
interested in learning what more can be done with Government
bond yields that have been so low for so long.
Following the June FOMC meeting, the Federal Reserve
announced it would continue its maturity extension program, the
Operation Twist, through the end of the year. I am interested
in learning what have been the results so far and what are the
expectations going forward.
Another drag on the economy are the hundreds of Dodd-Frank
proposed rules that will increase the cost of capital formation
in the long run and in the short term add to the climate of
uncertainty and complexity. The concern that I hear most is
that the regulators do not understand the cumulative effect of
the hundreds of proposed rules and that there is a lack of
coordination between our domestic and international regulators.
That is why it is so important that the regulators perform
meaningful cost/benefit analysis so that we can understand how
these rules will affect the economy as a whole, interact with
one another, and impact our global competitiveness.
Ultimately, we need to have rules that are strong enough to
protect our economy but that can adapt to changing market
conditions to promote credit availability and spur job growth
for millions of Americans.
Also, like many of my colleagues, I am learning about the
issues related to the setting of the London Interbank Offered
Rate, or LIBOR, which serves as a benchmark for trillions of
dollars of loans and derivatives, including the cost of many
mortgages in the United States. Recently, Barclays agreed to
pay a $450 million fine to settle manipulation charges brought
by the U.S. Department of Justice, the Commodity Futures
Trading Commission, and the United Kingdom's Financial Service
Authority.
Investigations that banks manipulated the LIBOR process are
continuing, and questions are being asked whether international
and domestic regulators, including the Federal Reserve, took
sufficient action. I look forward to hearing from Chairman
Bernanke on all of these issues, and, again, Mr. Chairman, I
welcome you here for your report today.
Chairman Johnson. Thank you, Senator Crapo.
To preserve time for questions, opening statements will be
limited to the Chair and Senator Crapo. 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.
With that, I would like to welcome Chairman Bernanke. Dr.
Bernanke is currently serving a second term as Chairman of the
Board of Governors of the Federal Reserve System. His first
term began under President Bush in 2006. Before that, Dr.
Bernanke was Chairman of the Council of Economic Advisers and
served as a member of the Board of Governors of the Federal
Reserve System.
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, Senator Crapo,
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 before turning to monetary policy.
The U.S. economy has continued to recover, but economic
activity appears to have decelerated somewhat during the first
half of this year. After rising at an annual rate of 2.5
percent in the second half of 2011, real GDP increased at a 2-
percent rate in the first quarter of 2012, and available
indicators point to a still smaller gain in the second quarter.
Conditions in the labor market improved during the latter
part of 2011 and early this year, with the unemployment rate
falling about a percentage point over that period. However,
after running at nearly 200,000 per month during the fourth and
first quarters, the average increase in payroll employment
shrank to 75,000 per month during the second quarter. Issues
related to seasonal adjustment and the unusually warm weather
this past winter can account for a part, but only a part, of
this loss of momentum in job creation. At the same time, the
jobless rate has recently leveled out at just over 8 percent.
Household spending has continued to advance, but recent
data indicate a somewhat slower rate of growth in the second
quarter. Although declines in energy prices are now providing
some support to consumers' purchasing power, households remain
concerned about their employment and income prospects, and
their overall level of confidence remains relatively low.
We have seen modest signs of improvement in housing. In
part because of historically low mortgage rates, both new and
existing home sales have been gradually trending upward since
last summer, and some measures of house prices have turned up
in recent months. Construction has increased, especially in the
multifamily sector. Still, a number of factors continue to
impede progress in the housing market. On the demand side, many
would-be buyers are deterred by worries about their own
finances or about the economy more generally. Other prospective
homebuyers cannot obtain mortgages due to tight lending
standards, impaired creditworthiness, or because their current
mortgages are underwater--that is, they owe more than their
homes are worth. On the supply side, the large number of vacant
homes, boosted by the ongoing inflow of foreclosed properties,
continues to divert demand from new construction.
After posting strong gains over the second half of 2011 and
into the first quarter of 2012, manufacturing production has
also slowed in recent months. Similarly, the rise in real
business spending on equipment and software appears to have
decelerated from the double-digit pace seen over the second
half of 2011 to a more moderate rate of growth over the first
part of this year. Forward-looking indicators of investment
demand--such as surveys of business conditions and capital
spending plans--suggest further weakness ahead. In part,
slowing growth in production and capital investment appears to
reflect economic stresses in Europe, which, together with some
cooling in the economies of other trading partners, is
restraining the demand for U.S. exports.
At the time of the June meeting of the Federal Open Market
Committee--FOMC--my colleagues and I projected that, under the
assumption of appropriate monetary policy, economic growth will
likely continue at a moderate pace over coming quarters and
then pick up very gradually. Specifically, our projections for
growth in real GDP prepared for the meeting had a central
tendency of 1.9 to 2.4 percent for this year and 2.2 to 2.8
percent for 2013. These forecasts are lower than those we made
in January, reflecting the generally disappointing tone of the
recent incoming data. In addition, financial strains associated
with the crisis in Europe have increased since earlier this
year, which--as I already noted--are weighing on both global
and domestic economic activity. The recovery in the United
States continues to be held back by a number of other
headwinds, including still tight borrowing conditions for some
businesses and households, and--as I will discuss in more
detail shortly--the restraining effects of fiscal policy and
fiscal uncertainty. Moreover, although the housing market has
shown improvement, the contribution of this sector to the
recovery is less than has been typical of previous recoveries.
These headwinds should fade over time, allowing the economy to
grow somewhat more rapidly and the unemployment rate to decline
toward a more normal level. However, given that growth is
projected to be not much above the rate needed to absorb new
entrants into the labor force, the reduction in the
unemployment rate seems likely to be frustratingly slow.
Indeed, the central tendency of participants' forecasts now has
the unemployment rate at 7 percent or higher at the end of
2014.
The Committee made comparatively small changes in June to
its projections for inflation. Over the first 3 months of 2012,
the price index for personal consumption expenditures rose
about 3.5 percent at an annual rate, boosted by a large
increase in retail energy prices that in turn reflected the
higher cost of crude oil. However, the sharp drop in crude oil
prices in the past few months has brought inflation down. In
all, the PCE price index rose at an annual rate of 1.5 percent
over the first 5 months of this year, compared with a 2.5
percent rise over 2011 as a whole. The central tendency of the
Committee's projections is that inflation will be between 1.2
to 1.7 percent this year and at or below the 2-percent level
that the Committee judges to be consistent with its statutory
mandate in 2013 and 2014.
Participants at the June FOMC meeting indicated that they
see a higher degree of uncertainty about their forecasts than
normal and that the risks to economic growth have increased. I
would like to highlight two main sources of risk: The first is
the euro-area fiscal and banking crisis, and the second is the
U.S. Fiscal situation.
Earlier this year, financial strains in the euro area
moderated in response to a number of constructive steps by the
European authorities, including the provision of 3-year bank
financing by the European Central Bank. However, tensions in
euro-area financial markets intensified again more recently,
reflecting political uncertainties in Greece and news of losses
at Spanish banks, which in turn raised questions about Spain's
fiscal position and the resilience of the euro-area banking
system more broadly. Euro-area authorities have responded by
announcing a number of measures, including funding for the
recapitalization of Spain's troubled banks, greater flexibility
in the use of the European financial backstops (including,
potentially, the flexibility to recapitalize banks directly
rather than through loans to sovereigns), and movement toward
unified supervision of euro-area banks. Even with these
announcements, however, Europe's financial markets and economy
remain under significant stress, with spillover effects on
financial and economic conditions in the rest of the world,
including the United States. Moreover, the possibility that the
situation in Europe will worsen further remains a significant
risk to the outlook.
The Federal Reserve remains in close communication with our
European counterparts. Although the politics are complex, we
believe that the European authorities have both strong
incentives and sufficient resources to resolve the crisis. At
the same time, we have been focusing on improving the
resilience of our financial system to severe shocks, including
those that might emanate from Europe. The capital and liquidity
positions of U.S. banking institutions have improved
substantially in recent years, and we have been working with
U.S. financial firms to ensure they are taking steps to manage
the risks associated with their exposures to Europe. That said,
European developments that resulted in a significant disruption
in global financial markets would inevitably pose significant
challenges for our financial system and our economy.
The second important risk to our recovery, as I mentioned,
is the domestic fiscal situation. As is well known, U.S. Fiscal
policies are on an unsustainable path, and the development of a
credible medium-term plan for controlling deficits should be a
high priority. At the same time, fiscal decisions should take
into account the fragility of the recovery. That recovery could
be endangered by the confluence of tax increases and spending
reductions that will take effect early next year if no
legislative action is taken. The Congressional Budget Office
has estimated that, if the full range of tax increases and
spending cuts were allowed to take effect--a scenario widely
referred to as the ``fiscal cliff''--a shallow recession would
occur early next year and about 1\1/4\ million fewer jobs would
be created in 2013. These estimates do not incorporate the
additional negative effects likely to result from public
uncertainty about how these matters will be resolved. As you
recall, market volatility spiked and confidence fell last
summer, in part as a result of the protracted debate about the
necessary increase in the debt ceiling. Similar effects could
ensue as the debt ceiling and other difficult fiscal issues
come into clearer view toward the end of the year.
The most effective way that the Congress could help to
support the economy right now would be to work to address the
Nation's fiscal challenges in a way that takes into account
both the need for long-run sustainability and the fragility of
the recovery. Doing so earlier rather than later would help
reduce uncertainty and boost household and business confidence.
In view of the weaker economic outlook, subdued projected
path for inflation, and significant downside risks to economic
growth, the FOMC decided to ease monetary policy at its June
meeting by continuing its maturity extension program, or MEP,
through the end of this year. The MEP combines sales of short-
term Treasury securities with an equivalent amount of purchases
of longer-term Treasury securities. As a result, it decreases
the supply of longer-term Treasury securities available to the
public, putting upward pressure on the prices of those
securities and downward pressure on their yields, without
affecting the overall size of the Federal Reserve's balance
sheet. By removing additional longer-term Treasury securities
from the market, the Fed's asset purchases also induce private
investors to acquire other longer-term assets, such as
corporate bonds and mortgage backed-securities, helping to
raise their prices and lower their yields and thereby making
broader financial conditions more accommodative.
Economic growth is also being supported by the
exceptionally low level of the target range for the Federal
funds rate of 0 to \1/4\ percent and the Committee's forward
guidance regarding the anticipated path of the funds rate. As I
reported in my February testimony, the FOMC extended its
forward guidance at its January meeting, noting that it expects
that economic conditions--including low rates of resource
utilization and a subdued outlook for inflation over the medium
run--are likely to warrant exceptionally low levels for the
Federal funds rate at least through late 2014. The Committee
has maintained this conditional forward guidance at its
subsequent meetings. Reflecting its concerns about the slow
pace of progress in reducing unemployment and the downside
risks to the economic outlook, the Committee made clear at its
June meeting that it is prepared to take further action as
appropriate to promote a stronger economic recovery and
sustained improvement in labor market conditions in a context
of price stability.
Thank you. I would be pleased to take your questions.
Chairman Johnson. Thank you for your testimony.
We will now begin the questioning of our witness. Will the
clerk please put 5 minutes on the clock for each Member?
Chairman Bernanke, I am going to lead off with a question
about the LIBOR scandal. Last week, you released documents
showing that the Fed provided early warnings on manipulation in
the LIBOR market. Then-New York Fed President Timothy Geithner
raised concerns with President Bush's Presidential Working
Group and offered reform recommendations to the British
authorities.
Can you tell the American people, what did you know, when
did you know it, and what did you do about it? What can we do
to restore confidence in the system?
Mr. Bernanke. Thank you, Mr. Chairman. As you know, LIBOR
is a critical benchmark for many financial contracts, so the
actions of traders and banks that have been disclosed are not
only very troubling in themselves, but they have the effect of
undermining public confidence in financial markets.
Regarding the Federal Reserve's role, the Federal Reserve
Bank of New York takes the lead in gathering market
intelligence for the Federal Reserve System. It was in the
process of gathering market intelligence when it received
information about LIBOR submissions, notably a phone call on
April 11, 2008, in which a trade in Barclays New York told an
employee of the Federal Reserve that he thought that Barclays
was underreporting its rate.
About that same time, stories began to appear in the media
as well. There was an April 16th story in the Wall Street
Journal, and the Financial Times also had a number of stories.
I would like to make two preliminary points before talking
about the Federal Reserve's response to that information.
First, the information the Fed received was about the banks
possibly submitting low rates in order to avoid appearing weak
during the period of the crisis. The transcripts of the phone
calls that were released have no reference to the manipulation
of rates for profit by derivatives traders, as alleged by the
recent decision.
The second point I would like to make is that this issue
was complicated during the crisis by the fact that there were
very few transactions occurring other than overnight, and so
banks were asked to report what they would pay if they were
borrowing at a certain term. It may have been in many cases
that transactions were not taking place at that term. We will
get more information on that as the investigations continue.
But it is clear that, beyond these disclosures, the LIBOR
system is structurally flawed, and part of the response was to
address those flaws.
The Federal Reserve Bank of New York, after receiving this
information from its market inquiries, responded very quickly.
It set up an internal working group to address the issue.
Importantly, it informed all the relevant authorities in both
the U.K. and the United States. Notably, on May 1st, then-
President Geithner briefed the President's Working Group, which
consisted of the Treasury, the Fed, the CFTC, and the SEC,
among other participants. The New York Fed briefed the Treasury
separately on May 6th. The PWG meeting was followed up with
interagency staff briefings to provide more information to the
staffs of the various agencies. And the New York Fed also
communicated with the FSA and the Bank of England in the United
Kingdom. So there was active effort to report to all the
relevant policymakers and enforcement agencies the information
that had been received.
The second step that the Federal Reserve Bank of New York
took was to develop recommendations to address the structural
problems with LIBOR that I mentioned before. The New York Fed
released a memorandum, a list of suggested changes that they
submitted to the Bank of England on June 1st and following
earlier discussions with the Bank of England. There were also
communications with the British Bankers Association, which is
the private group that constructs LIBOR, prior to June 1st.
So the Federal Reserve Bank of New York took the lead here.
They released a good bit of information. They are looking for
additional information, and they will certainly release it if
they find it.
On the Board's side, we were in supporting mode. We
provided analytic support, notably about the issues related to
the construction of LIBOR. Our staff were in contact with the
CFTC in April and May to provide analytical support. And
Governor Kroszner on the Board at that time was in contact with
the British authorities and the BBA during May and June.
I think it is important to note that, following the Federal
Reserve Bank of New York's disclosures to the appropriate
authorities, there was rapid followup. The CFTC was making
inquiries as early as April 2008. It sent requests for
information to U.S. banks in the fall of 2008. The SEC
initiated inquiry in 2009 and the DOJ in 2010. Currently, the
European Commission and a range of other foreign regulators,
including British regulators, of course, are also
investigating. And, of course, we know about the June 27th
settlement with Barclays.
So there was a substantial response by the Federal Reserve
Bank of New York both in terms of informing all the appropriate
authorities. That information led to investigations. The
Federal Reserve Bank of New York also contributed substantially
to thinking about how to better structure the LIBOR panel and
the LIBOR information collection to avoid some of the
weaknesses in the system that became evident during the crisis.
Chairman Johnson. Chairman Bernanke, what are the factors
that led you to support the extension of the so-called
Operation Twist program? And what changes in economic
conditions might lead you to consider a strong policy response
in the future? If further extensions of Operation Twist are not
possible in the future, what other policy tools are available
if the Fed decided to provide additional monetary support?
Mr. Bernanke. Well, as you know, Mr. Chairman, the Federal
Reserve in December 2008 brought rates down close to zero, and
since then we have had to rely on a number of less conventional
policy tools in order to achieve additional financial
accommodation, and those included, of course, as was mentioned,
quantitative easing programs, and the Operation Twist, which,
as I discussed in my remarks, also provides extra financial
accommodation and provides support for the recovery.
The other type of tools that we have include communication
tools, notably our forward guidance, which gives the markets
some sense of where we think--or how long we think that rates
will be kept at their current low level.
So those are the principal types of tools that we have. We
are looking very carefully at the economy, trying to judge
whether or not the loss of momentum we have seen recently is
enduring and whether or not the economy is likely to continue
to make progress toward lower unemployment and more
satisfactory labor market conditions.
If that does not occur, obviously we have to consider
additional steps. We have looked at a range of possible tools,
mostly, again, involving the balance sheet and communication.
The Committee meets in a couple of weeks, and we will be
discussing those tools. We have not really come to a specific
choice at this point, but we are looking for ways to address
the weakness in the economy should more action be needed to
promote a sustained recovery in the labor market.
Chairman Johnson. Senator Crapo.
Senator Crapo. Thank you, Mr. Chairman.
Chairman Bernanke, ever since the Dodd-Frank conference,
there has been a debate about whether nonfinancial end users
were exempt from margin reforms. Then-Chairman Dodd and
Chairman Lincoln acknowledged that the language for end users
was not perfect and tried to clarify the intent of the language
with a joint letter. In the letter, they stated, ``The
legislation does not authorize the regulators to impose margin
on end users, those exempt entities that use swaps to hedge or
mitigate commercial risk.''
In April 2011, prudential regulator issued a joint proposal
that would, in fact, require nonfinancial end users to post
margin to their bank counterparties.
According to the proposed rule, the proposal to require
margin stems directly from what they view to be a legal
obligation under Title VII. Recently, I offered an amendment
with Senator Johanns to fulfill congressional intent by
providing an explicit exemption from margin requirements for
nonfinancial end users that qualify for the clearing exemption.
The amendment is identical to the House bill which passed the
House by a vote of 370-24.
Is it accurate, in your opinion, that regardless of
congressional intent, the banking regulator view the plain
language of the statute as requiring them to impose some kind
of margin requirement on nonfinancial end users unless Congress
changes the statute?
Mr. Bernanke. We believe that the statute does require us
to impose some type of margin requirement. We tried to mitigate
the effect as much as possible by allowing for exemptions when
the credit risk associated with the margin was viewed as being
sufficiently small. So many small end users would be exempt in
practice.
Senator Crapo. Do you agree that the nonfinancial end
users' hedging does not contribute to systemic risk, that the
economic benefits from their risk management activity--excuse
me, that the economy benefits from their hedging activity and
that it is appropriate for Congress to provide an explicit
exemption from margin requirements for nonfinancial end users
that qualify for the clearing exemption?
Mr. Bernanke. I certainly agree that nonfinancial end users
benefit and that the economy benefits from the use of
derivatives. It seems to be the sense of a large portion of the
Congress that that exemption should be made explicit, and
speaking for the Federal Reserve, we are very comfortable with
that proposal.
Senator Crapo. Well, thank you, Mr. Chairman.
I want to shift gears for just a minute back to the
question that the Chairman asked with regard to what actions
you can take. You indicated in your response to his question
about what tools you still have and how you may approach them
that you still have some possible tools to deal with. There is
obviously a lot of speculation and concern about whether you
are considering another round of quantitative easing. There are
a lot of questions about how effective quantitative easing has
been to date and what more can be done.
Could you discuss for us a moment how effective you feel
that the quantitative easing has been so far and whether you
feel that it is one of those tools that you should seriously
consider going forward?
Mr. Bernanke. So as I mentioned to the Chairman, we ran out
of space to lower short-term rates in the normal way, and we
had to look for other tools. Like a number of other major
central banks, we have used asset purchases as a way of
providing additional support to the economy.
Economists differ on terms of how effective the tools have
been. My own assessment is that the quantitative easing and the
Operation Twist so-called tools have been effective in easing
financial conditions and in promoting strength in the economy,
and it was most evident in the so-called QE1 in March 2009,
which was followed a few months later by the beginning of the
recovery and, by a few days, by the trough in the stock market.
QE2 was certainly effective at addressing what was
beginning to become a worrisome amount of risk of deflation in
the fall of 2010. That issue was addressed. My view and the
view of our analysts at the Fed is that it also contributed to
economic growth. It is hard to judge because it depends on what
you think would have happened in the absence of those actions.
So there is a range of views about the efficacy of these
programs. There are also questions about side effects, risks
that might be associated with their use, and, therefore, I
think they should not be used lightly. Nevertheless, my own
view is that these tools and other nonstandard tools still do
have some capacity to support the economy, and what we will be
looking at in thinking about this is, I think, really two
things: The first is, as mentioned in our statement, whether or
not there is, in fact, a sustained recovery going on in the
labor market or are we stuck in the mud, so to speak, in terms
of employment. That is, of course, our maximum employment
mandate. And then the other issue would be price stability, and
notably we would certainly want to react against any increase
in deflation risk.
Senator Crapo. Thank you,
Chairman Johnson. Senator Reed.
Senator Reed. Thank you very much, Mr. Chairman, and thank
you, Chairman Bernanke.
Let me return for a moment to the issue of LIBOR. Can you
give us and the millions of Americans who depend upon LIBOR
because it tells them how much they have to pay for their car
loan or their student loan, et cetera, that the current LIBOR
is reliable, that the changes that were made or suggested by
the New York Fed or others have been put in place, and that
this is an index that is, in fact, reliable and not being
subject to manipulation going forward?
Mr. Bernanke. I cannot give that assurance with full
confidence because the British Bankers Association did not
adopt most of the suggestions that were made by the Federal
Reserve Bank of New York. They made a relatively small number
of changes. I think it is likely that concerns are less now
because we are no longer in the crisis period, and that, as I
mentioned, was a period in which transactions and many
maturities were not taking place. I would like to see
additional reforms to the LIBOR process, assuming that LIBOR
will continue to be a benchmark for financial contracts.
Alternatively, there are a number of people looking at
alternative benchmarks, like repo rates or the overnight index
swap rate or other types of interest rates which have the
advantage over LIBOR that they are market rates as opposed to
simply reported rates.
Senator Reed. What steps are you taking, though, given that
concern you have expressed, right now, not retrospectively, how
we got here and who did what to do, but to provide as much
certainty as you can--there are several banking institutions
you directly regulate that contribute to LIBOR. There is your
relationship directly with the Bank of England. What are you
doing--not just you personally but the Federal Reserve--to
ensure this index is appropriate? And, again, I encourage you
to study these alternatives, but the LIBOR is so deeply
interwoven and embedded into thousands and thousands of
contractual arrangements throughout the world that it is going
to be hard to next week shift to something else.
Mr. Bernanke. Well, again, I think we are and need to
continue advocating for reforms to the LIBOR process. It is
constructed by a private organization in the U.K., and so our
direct ability to influence that is limited.
With respect to the three banks in the United States which
contribute to the LIBOR panel, two of those banks have reported
in their SEC filings that they have been asked for information
by investigating agencies. We are following that very
carefully. We will see what happens, and we will provide any
support and help we can to those investigators.
Senator Reed. Let me turn to more the monetary issue. The
Federal Reserve has been in some cases sort of pursuing
aggressive monetary policy while fiscal policy has not kept up
in some respects, and I presume you are prepared to continue to
do that given the unemployment numbers, inflation numbers, et
cetera. That is regardless of what we are doing on the fiscal
end.
Mr. Bernanke. Our mandate tells us to do the best we can
for employment and price stability, and we will continue to do
that. Of course, we would appreciate other policymakers playing
appropriate roles themselves as well.
Senator Reed. One of the comments that you made--and will
give you a chance to amplify it--is that there will be a need,
I think in your view, next year for continued stimulus, for
want of a better term, if we are going to reduce unemployment,
which is one of your mandates, and that if we reach a solution
that is heavy on cuts to spending, that is heavy perhaps even
on cuts to entitlements, that would not provide stimulus, in my
view, and it could further impact unemployment in the country.
Is that an accurate assessment?
Mr. Bernanke. Well, the position we have taken is, I would
say, at a first cut is do no harm. What we need is a strategy
which addresses the long-run sustainability issues. We cannot
forget about that. At the same time, if the fiscal cliff is
allowed to happen, it will certainly have major negative
effects on the recovery. The CBO, the IMF, and many other
observers have made similar recommendations, and we feel that
is a reasonable balance between the short and long term.
Senator Reed. Some of the specific issues that we face at
the end of the year are filling a gap in 2013 in terms of
spending, in terms of revenues. And if that 2013, if we avoid
the cliff by taking another route, but that route significantly
decreases spending, decreases other stimulative effects, would
your view be that we could have avoided a cliff but still found
ourselves in a very perilous economic situation because
employment will continue to decline?
Mr. Bernanke. It is a question of the timeframe. In the
very near term, we already have a lot of fiscal drag coming
from State and local governments, for example, as you know, and
some coming inevitably from the Federal side. So in no way am I
saying that we should not be making strong efforts to achieve
long-term sustainability and make a credible plan as soon as
possible for doing that. But it would be better to make that
plan soon but to have the effects come in more gradually to
allow the recovery the air it needs in the short term.
Senator Reed. Thank you, Mr. Chairman.
Chairman Johnson. Senator Corker.
Senator Corker. Thank you, Mr. Chairman. And thank you, Mr.
Chairman, for being here. I was listening to the last dialog
there, and I know in your statement you talked about the fiscal
cliff that is coming up. And to be clear about the spending
reductions, it is $1.2 trillion over the next 10 years that the
sequestration amounts to. We are going to spend about $45 to
$47 trillion of taxpayer money over the next 10 years. And
while I agree we should come up with a much better solution
that deals with entitlements and revenues and hopefully
something that is much larger, are you seriously concerned that
we are talking about $108 billion next year in reductions, half
between defense, half in other mandatory spending, you are
seriously concerned that that small amount of spending
reductions is something that is going to damage the economy?
Mr. Bernanke. The fiscal cliff includes both the spending
reductions and the tax increases.
Senator Corker. I am talking about just the spending piece.
It is hard for me to believe----
Mr. Bernanke. Obviously, a smaller fiscal contraction will
have a smaller effect. But, you know, I do not want to make a
judgment about--I realize it is very contentious, taxes versus
spending. I do not want to get into that. But, clearly, a
smaller reduction in the fiscal position would have less effect
on the economy than a larger one.
Senator Corker. Yes. But as we look at the economy, would
you not also say that the best thing we could do to stimulate
the economy, including any actions the Fed might take, is for
us to have real balanced fiscal reform? Is that not the thing
that would cause our economy to take off more than anything
else and alleviate the uncertainty that people have, the
investing community?
Mr. Bernanke. Fiscal reform is very important, not only the
control of deficits over the long period but also the quality
of fiscal policy: What are we spending our money on? What does
our Tax Code look like? I think those things are extremely
important.
But I think the way the current law is written, we have the
maximum impact right in the very short run on January 1, 2013,
and much less happening over the next decade or the next two
decades. So I am not advocating an overall increase in fiscal
spending or anything like that. I am just saying that the
timing should be adjusted to allow the recovery a little bit
more space to continue, but to make a serious efforts to
improve our fiscal policy over the next decade.
Senator Corker. So, look, I agree that we should have a
better policy than we now have, and I think most of the people
on this dais are trying to seek that, and it is unbelievable to
me that we have not already done that. But I think, on the
other hand, for us to potentially kick the can down the road on
sequestration creates even more--if we do not come up with
another solution, which I hope we will, but to say that you are
recommending in some ways that we kick the can down the road,
not do sequestration, and make us look even more irresponsible
to me is worse than the $108 billion that might be reduced out
of the spending that the Federal Government is going to be
doing this next year. Do you understand what I am saying?
Mr. Bernanke. Yes, sir, and I think just delaying
everything, just saying we are not going to do it, put it off a
year, I think that would be a very bad outcome.
Senator Corker. So I think the actions that you are taking
at the Fed--and I understand you have a dual mandate. I think
we should have a single mandate, and I know we have talked
about that. I know that it creates bipolar activity because you
are trying to juggle the two, and we have created that, not
you. But I think the actions that you are taking really take
the--or you are potentially considering--I know QE2 was in
response to potential deflation. I think further actions
actually take the impetus off us to act responsibly. And I
candidly wish we had a Chairman of the Fed that sometimes would
say, look, we are not doing anything else, we are pushing rope,
and it is up to you to act responsibly to deal with these
fiscal issues, quit looking to us.
I mean, are you tempted ever to say that to Congress? Would
you not say that now?
Mr. Bernanke. I do not think that is my responsibility. I
have been assigned to focus on maximum employment and price
stability, not to hold threats over Congress' head. Congress is
in charge here, not the Federal Reserve.
Senator Corker. A very politic answer. I would say that,
you know, you have members that are concerned about the
policies that you are putting in place being disruptive. You do
have members who are concerned about that. Is that correct?
Mr. Bernanke. We have a range of views on the Committee,
yes.
Senator Corker. And let me ask it a different way. If we
were to act responsible and to do something in a balanced way
that deal with not only the next 10 years but 20 and 30, which
most of the plans that have been in the mainstream do that,
would that alleviate the need possibly for the Fed to consider
additional quantitative easing?
Mr. Bernanke. Well, possibly. As I said, the fiscal issues
are a major concern, a major downside risk, and if Congress
addressed those issues and the economy was--the outlook was
better, then it is certainly very possible that that would
abrogate any need to take further action.
Senator Corker. You have been a little vague on what
additional tools you have, and I understand that. I know the
whole world watches when you speak. It does appear that most of
the toolkit is utilized at this moment.
If you were to consider additional tools at the Fed in the
next meeting, what would be the range of options that might
exist with rates being where they are today and Operation Twist
being in effect? I mean, what else is there that the Fed can
responsibly do since the Fed is the biggest lender to the
Federal Government already, far more than China and Japan?
Mr. Bernanke. Well, there are a range of possibilities, and
I do not want to give any signal that we are choosing one----
Senator Corker. Well, what is the range?
Mr. Bernanke. The logical range includes different types of
purchase programs that could include Treasurys or include
Treasurys and mortgage-backed securities. Those are the two
things we are allowed to buy. We could also use our discount
window for lending purposes, but, you know, that is another
possibility. We could use communication to talk about our
future plans regarding rates or our balance sheet. And a
possibility that we have discussed in the past is cutting the
interest rate we pay in excess reserves. That is a range of
things that we could do. Each one of them has costs and
benefits, and that is an important part of the calculation.
Senator Corker. Thank you for your service and for being
here.
Chairman Johnson. Senator Schumer.
Senator Schumer. Well, thank you, Mr. Chairman.
I, too, thank you for your service. I think you have done a
superb job in one of the most difficult periods to be Chairman
of the Fed.
Now, I do not quite agree with my good friend Mr. Corker. I
think you have told Congress what you want us to do in your own
Fed-speak way of doing it. Just last month, you said you would
be ``more comfortable if Congress took off some of the burden
in terms of helping the Fed in our economic recovery.''
What he meant there is not deficit reduction. He meant
stimulus. He meant some kind of stimulus, which is the opposite
side of the Fed.
Now, I agree with you. Under current conditions, fiscal
policy should be our first choice. It would be more effective.
Unfortunately, we can talk all we want--everyone gives speeches
how fiscal policy should be the way to go, and we do not do
anything. We have had a hard getting the cooperation necessary
to get anything done on the fiscal side. We have tried tax
cuts, which supposedly our colleagues on the other side of the
aisle like. We have tried increased investments in
infrastructure, a traditional way of priming the pump. We have
tried support for State and local governments where jobs are
declining, and we have run into opposition on all fronts.
Just last week, on two things that our colleagues have
often supported--a tax credit for job creation and accelerated
depreciation for capital purchases--we got no support.
So the bottom line is very simple. We are not going to get
the fiscal relief we want, at least over the next short while.
Maybe after November we will.
So given the political realities--and the President has
been calling for this repeatedly. When the President last fall
proposed short-term fiscal support combined with long-term
deficit reduction, which to me is the right way to go, a 10-
year plan that really reduces our deficit but a 1- or 2-year
plan that pumps the economy up a little bit, he did not get a
single Republican vote. And we know the reality. You cannot do
it if it is not bipartisan.
So given the political realities, Mr. Chairman,
particularly in this election year, I am afraid the Fed is the
only game in town. And I would urge you to take whatever
actions you think would be most helpful in supporting a
stronger economic recovery.
You have received some harsh criticism for past efforts to
help the economy. Republican leadership in the House and
Senate, even as they were blocking jobs bills in Congress, sent
you a letter opposing more monetary support as well. Well, I
would urge you now more than ever to take whatever actions are
warranted by the economic conditions, regardless of the
political pressure.
To that end, the minutes of your last FOMC meeting notes
that the forecast for real GDP growth was revised down, the
unemployment rate remained elevated, and consumer price
inflation declined. Moreover, the economy showed that not a
single member of the Committee thought employment would be back
to normal levels by the end of 2014. Not a single member
forecast inflation even modestly above your 2-percent target in
the same timeframe. So the recession is deeper, more prolonged,
and stickier than anyone thought. And let us remember, the Fed
has a dual mandate: first and foremost to guard against
inflation, but also to keep unemployment up and--sorry, to keep
employment up and unemployment down. So, to me, these
conditions would certainly motivate the Fed to seriously
consider taking further action to bolster the economy.
What is your opinion about that?
Mr. Bernanke. We take the dual mandate very seriously. We
will act in an apolitical, nonpartisan manner to do what is
necessary for the economy. We have said we are prepared to take
further action. The complication, of course, is that we are
dealing with less conventional tools, and we have to make
assessments about their efficacy and whatever costs and risks
may be associated with them. But it is very important that we
see sustained progress in the labor market and avoid deflation
risk, and those are the things we will be looking at as the
Committee meets later this month and later this summer.
Senator Schumer. And you still do--I mean, you have used
QE1 and QE2, but you still have some other tools in your
toolkit?
Mr. Bernanke. I believe we do, yes.
Senator Schumer. OK. And do you agree that at least for the
next few years the danger of inflation is quite low?
Mr. Bernanke. Well, our projection of inflation is that it
will be close to or below our 2-percent target, and, yes, so I
think inflation risk is relatively low now. Not everyone agrees
with that, but my personal opinion is that that risk is
reasonably low right now. And indeed, as I mentioned, there is
a modest risk--not a large risk but a modest risk--of going in
the other direction, which is toward the deflationary side.
Senator Schumer. And you certainly agree that unemployment
has been too high and is sticky, and despite two false starts,
we are having a much rougher time than we ever imagined getting
unemployment down?
Mr. Bernanke. Yes, that is true.
Senator Schumer. So get to work, Mr. Chairman.
Chairman Johnson. Senator DeMint.
Senator DeMint. Thank you. Thank you, Mr. Chairman, for
being here. It is interesting to hear my colleagues talk, and
they seem puzzled why our short-term temporary stimulus
gimmicks do not seem to work. And by any analysis, the cliff
that is at the end of this year was created by all of these
temporary policies that expire at the same time.
Clearly, we are throwing a lot on you, but at the same time
it appears that we are forcing you into temporary, short-term
ideas. And I am concerned that--you mentioned costs and
benefits, some of the things that you are clearly considering,
such as quantitative easing, as costs that we do not talk
about, at least on our side, as well as keeping the interest
rates low. I mean, you are well aware that keeping interest
rates where they are is costing Americans about $400 billion a
year in lost interest on any savings that they might have. So
there is a real cost, and over the last 4 years, probably about
$1 trillion in loss. So people who are actually trying to save
and put aside dollars are on a negative treadmill in the sense
that they are losing the value on their dollars. So there is a
cost to that stimulus effect. And also a quantitative easing,
which you are clearly considering, our own Federal Reserve Bank
of New York estimates that about 50 percent of the value of the
S&P over the last decade is related to Fed action and the
buildup around Fed action of quantitative easing.
My concern now is that what we are seeing is not an
increase in the value of stock but a projection and a loss of
value of our dollar. And while we talk about no inflation, I
think what we are talking about is no visible inflation at this
time, because clearly, if we are printing more money to buy
more of our national debt--and I think you will agree the
Federal Reserve through intermediaries has bought over half of
our debt the last couple of years--we are diluting the value of
our dollar over time. And while it may not show up today or
tomorrow, it is inevitable that it will show up. And I think we
see that in the reflection of the price of stocks because it is
obvious that that does not reflect long-term projections of
value and profits as much as it does playing a market and what
is coming out of the Federal Reserve.
So my concern very much now is another announcement of
quantitative easing, which might inflate the stock market
temporarily, but another short-term effort that might help
employment in the short term but actually reduce the value of
the dollar and, therefore, everything we have worked for here
in the country. So how are you gauging the cost of another
round of quantitative easing?
Mr. Bernanke. Well, let me respond to the specifics that
you raised. On savings, we understand that low interest rates
are a hardship for many people. The reason the interest rates
are low, of course, is that we are trying to promote a recovery
in the economy. People hold fixed-income types of securities,
like CDs or Treasury bonds, but they also hold stocks or
corporate bonds or small businesses or other types of assets
which depend on the strength of the economy. And raising
interest rates might help some folks, but if it caused the
economy to weaken considerably, it would be bad for investors
broadly speaking.
So what we are trying to do, of course, as our mandate
suggests is to strengthen the economy, which in turn should
make America a more attractive place to invest, provide higher
returns for everyone investing in the United States.
On the dollar and inflation, I appreciate your concern, and
that is obviously one of the things we have paid very close
attention to. We have not seen inflation yet, though, and the
dollar has been, in fact, recently a good bit stronger. And we
are comfortable that we have the tools to unwind these policies
in a way that will not threaten inflation. But as I said to
Senator Schumer, we take both sides of the mandate very
seriously, and as we are looking to try to help reduce
unemployment, we also want to be confident that we maintain
price stability in the United States. And thus far we have been
successful in doing that.
Senator DeMint. The dollar is stronger relative to the
euro, but comparative values inside the United States just
cause some concerns at this point. But, again, I appreciate
what you do. I would just ask caution in diluting our dollar
even further for temporary action.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Menendez.
Senator Menendez. Thank you, Mr. Chairman.
Thank you, Chairman Bernanke, for your service. I want to
speak to you about interest rate manipulations by large banks
since the Fed plays a role, a key role in ensuring the
integrity of interest rates that affect consumers, small
businesses, and cities and towns across the country.
You know, I look at this most recent set of allegations on
the LIBOR manipulation, and once again it exposes to me a
culture of greed, a culture of cheating, of lying, at least at
one large bank, and probably many more, which is why nine of my
colleagues and I wrote to you and other banking regulators and
the Department of Justice last week asking for a robust
investigation in the role of these banks and how this
ultimately affected consumers in this country, investors in
this country, cities in this country, because LIBOR is a very--
it is far more than a benchmark. It is a very significant
indicator here that is used.
I know that the Federal Reserve Bank of Cleveland found
that 45 percent of prime adjustable rate mortgages are indexed
to LIBOR; 80 percent of the subprime ARMs use LIBOR as a
benchmark. So this is a huge issue, and it again goes to the
integrity of our financial system, and the lack of faith, I
think, increasingly that the American public and, for that
fact, many of us are having in the system.
I looked at the internal emails during 2005 and 2007 of
Barclays' derivative traders asking other employees to submit
false survey responses in order to benefit their trading
positions, changing them, preferring certain LIBOR outcomes on
certain days, sometimes for it to be higher, sometimes for it
to be lower, depending upon how it would benefit their
position.
Now, I look at this, and I say to myself this is about
trying to manipulate a key economic indicator for the purposes
of profit. Am I wrong on that?
Mr. Bernanke. No, I agree absolutely. This is unacceptable
behavior.
Senator Menendez. Well, let me ask you, clearly, then,
banks like Barclays were trying to profit from the LIBOR
manipulation, but that profit came not at, you know--actually,
it came at the expense of the public in general.
Mr. Bernanke. Some of the public. It is actually an
interesting question. You mentioned borrowers. Borrowers may
have benefited because LIBOR was underreported. We will
probably find out via a number of lawsuits that have been
filed, and investigations, exactly how much effect there was.
Senator Menendez. But if you got caught in that period of
time in which the traders wanted the higher LIBOR and that was
a time in which your adjustment was going on, you had a
detriment to yourself. Investors obviously had a detriment in
not knowing the integrity of the institutions, not knowing
the--you know, LIBOR, if it is lower, it means things are
working pretty well. When it goes higher, it is sort of like a
warning sign, is it not?
Mr. Bernanke. I am not defending it. I think it is a major
problem for our financial system and for the confidence in the
financial system, and we need to address it.
Senator Menendez. So how do we address it? For example, I
know that some of my colleagues here bristle at regulation, but
it seems that this is an industry that on its own will not work
with the integrity that the public deserves. We are talking
about pension fund investments, mutual fund investments,
investments by regular investors, as well as the consequences
to consumers. I am sure that we are talking about billions in
effect, if not trillions in effect.
For example, do you think that we need additional internal
controls or firewalls between reporting personnel and trading
employees at these banks so that we do not have this work to
manipulate as one example of--I would like to hear what it is
we are going to do now that we know all of this, and may have
known it before. We are we going to do to ensure the integrity
of this banking system?
Mr. Bernanke. Well, first, it is going to have to be an
international effort because--LIBOR is constructed by the U.K.
organization, and, of course, LIBOR is constructed for about
ten different currencies as well. So it has to be an
international effort.
I think there are broadly two approaches. One would be to
fix LIBOR, to make changes to it to increase the visibility, to
reduce the ability of individual banks or traders to affect the
overall LIBOR, and to increase monitoring of the reporting
process that is done. So that would be one strategy.
The other strategy, which many people are thinking about,
is going from what is essentially a reported rate to an
observable market rate as the index, and there are a number of
possible candidates that have been advanced that might
ultimately replace LIBOR. As you point out, though, LIBOR is
very deeply ingrained in many contracts, and so that change
will be not a simple one to make. But I agree with you that we
need to address this problem.
Senator Menendez. Well, I would look forward to the Fed's
leadership in this regard and suggestions of how we, in fact,
make a system that cannot be manipulated, that has consequences
to millions of consumers, investors, pension funds,
municipalities, counties, Governments, all affected by LIBOR.
And so it may be an international response that we need, but we
need to understand what we can do here in the United States to
ensure for these investors and these consumers.
Chairman Johnson. Senator Vitter.
Senator Vitter. Thank you, Mr. Chairman, and thank you,
Chairman Bernanke, for your report.
On the LIBOR issue, from everything I have read, reports as
well as documents, it seems like in 2008, when the New York Fed
learned of this potential scandal, potential misreporting, it
reacted on the policy side with various discussions,
recommendations, with their British counterparts. I have not
seen anything about it reacting as a regulator of U.S. large
banks. Did it do anything to investigate whether U.S. banks
were guilty of the same practice?
Mr. Bernanke. Well, what it did was it informed the
responsible authorities--the CFTC in particular--very quickly.
The Bank of New York made a presentation to the President's
Working Group that included the SEC and the CFTC, provided
supporting information, as did the Board. So the investigations
took place, but they were taken up quite quickly by not the
Fed, which is a safety and soundness regulator, but by the
authorities that had the most direct responsibility for those
issues.
I have to say that the Federal Reserve Bank of New York is
still investigating the situation itself, digging up documents
and the like. I do not know what communications or
conversations were had with the three U.S. banks that were on
the panel, but the actual enforcement actions were taken by the
CFTC and SEC and DOJ.
Senator Vitter. So as we sit here today, do we know
definitively that no U.S. banks were guilty of the same
manipulation?
Mr. Bernanke. No, we do not know that.
Senator Vitter. Well, it seems to me that goes back to my
question and my concern. If we do not know that, it seems like
somebody dropped the ball, the fact that we are 4 years later
and we do not know that.
Mr. Bernanke. Well, I mean, as I said, two banks have
reported that they have been asked to disclose information to
the investigating agencies, and so a robust process is
certainly underway.
Senator Vitter. It is underway 4 years later. My point is
that knowledge of this occurred in 2008, and neither the New
York Fed nor other regulators did a sufficient investigation so
that we could know one way or the other as we speak today 4
years later that the U.S. banks did not do the same thing. Am I
missing something?
Mr. Bernanke. Only that, again, I think the responsibility
of the New York Fed was to make sure that the appropriate
authorities had the information, which is what they did.
Senator Vitter. Do you think it was a reasonable
responsibility for the New York Fed to follow up and say did
U.S. banks that we are a primary regulator of do the same
thing?
Mr. Bernanke. I do not know what conversations they had. Of
course, the New York Fed is the regulator of some banks and of
holding companies. There are other regulators, like the OCC and
so on.
Senator Vitter. But certainly the New York Fed is the
primary regulator of the biggest banks with regard to--U.S.
banks engaged in LIBOR that we are talking about, correct?
Mr. Bernanke. Two of the three.
Senator Vitter. Right. Let me move on to another topic that
I am concerned about. The Fed is in the process of rulemaking
with regard to the term ``predominantly engaged in financial
activities'' under Dodd-Frank. The rule that has been published
and the Fed is now taking comments on seems to me absolutely
ignores a very specific criteria that we in Congress placed in
Dodd-Frank in Section 102(a)(6). I know about it because it was
a Vitter-Pryor amendment, and it is very specific. It uses an
85-percent test. And it seems to me the rule the Fed is in the
process of adopting ignores that specific metric.
How can the Fed adopt a rule that ignores specific
statutory language?
Mr. Bernanke. We would not want to do that, and I will
check on that question for you.
Senator Vitter. OK. If you could check on that, again, it
is 102(a)(6). And I believe the Fed rule that has been
published for comment ignores a specific metric in the law,
which I would short term call the 85-percent rule, which was a
Vitter-Pryor amendment, which is in final law.
Mr. Bernanke. Thank you for that.
Senator Vitter. Thank you very much.
Finally, capital standards for the largest banks. As I have
read your comments in the past, it seems to me that you support
somewhat larger capital requirements for mega banks, but that
you seem to think where we are headed, about 9.5 percent under
Basel III, which is about 2.5 percent more for the mega banks,
is roughly appropriate. Is that a fair summary or not?
Mr. Bernanke. Well, there is an international standard
which it is not the same for every big bank. It starts at
virtually zero for the medium-size banks and then increases up
to the largest banks. But it is based on some formulas and some
calculations that try to establish parity across banks around
the world.
Senator Vitter. Well, I guess what I am asking is: To the
extent that imposes higher capital standards on the largest
U.S. banks, do you think those higher standards are good enough
to ensure stability in the future and protection in the future?
Mr. Bernanke. I think they are very useful, very important.
Basel III in general is going to increase everybody's capital
and increase the quality of capital, and this will mean that
the largest banks have even additional capital. But it is not
just capital. It is also going to be the market discipline that
comes from orderly liquidation authority, stronger supervision,
liquidity requirements, and so on. I think it is extremely
important that we address too big to fail, and this is one way
to make banks take into account that their own size does impose
a cost on the rest of society and make them respond to that.
Senator Vitter. Beyond the path we are on, do you think we
should be looking at higher capital requirements for the
biggest banks?
Mr. Bernanke. Well, we will continue to have international
discussions. It has been our approach to try to have capital
requirements that are broadly consistent with the international
standards, and these numbers were based on calculations that
drew from the crisis. But we are always open to further
discussions, and we will see how effects of the higher capital
work through the credit system as we go forward. We are phasing
this in relatively slowly, as you know, so we will get a chance
to see what the impact is on banks and credit costs.
Senator Vitter. My time is up, but I would encourage you to
look at that, and I would encourage you to place safety and
stability ahead of--I understand the desire for uniformity
across the globe, but I do not think it should trump what is
best for----
Mr. Bernanke. You are looking forward to higher capital
requirements.
Senator Vitter. Yes.
Chairman Johnson. Senator Akaka.
Senator Akaka. Thank you very much, Mr. Chairman.
Let me add my welcome to Chairman Bernanke to the Committee
and to thank you so much for your tireless leadership in these
challenging times.
Recent economic events in Europe and China show us how
dependent the United States is on the international markets
when it comes to our economic recovery. Despite concerns about
the overall rate of recovery, some sectors are beginning to
turn around and we are beginning to see some bright spots, as
indicated in your opening statement.
Hawaii, for example, had record tourism numbers in May, and
nationally we see spending by foreign travelers continue to
rise, helping to reduce our deficit.
My question is: How do you think that current policies and
those regarding tourism and exports have affected the recovery?
And, also, do you have any suggestions on how to further
encourage growth in these areas?
Mr. Bernanke. Well, first, Senator, tourism has been
something of a bright spot. We have seen improvements in
tourism in not just Hawaii but in a number of places around the
country. And you mentioned the international trade deficit.
People may not appreciate that when a foreigner comes and
visits Hawaii, that actually counts as a U.S. export because we
are exporting the tourism services. And the export of tourism
services has actually been growing very quickly, something like
14 percent in the last year, faster than other types of
exports. And so it contributes to our trade balance as well as
to overall economic activity. So it is a positive.
With respect to policies that address it, you know, I think
there is a lot of incentive. We see that individual States, for
example, compete with each other to try to attract visitors.
But we can consider issues like visa policies; we can look at
any tax or other implications that might affect the cost of
tourism. So it is an area where I think there is a lot of
benefit and a lot of scope for economic benefit to Hawaii and
the rest of the country. And it has so far been, as I said, a
bright spot among the various service industries that we have.
Senator Akaka. Thank you.
As you know, I am concerned with the well-being of
consumers. During previous hearings, you and I have discussed
the importance of improving financial literacy to empower
consumers while we work to grow the economy. So my question is:
In what ways have you seen financial decision making by
individual Americans improve during this recovery? And what
more needs to be done, do you think?
Mr. Bernanke. Well, there are two sides to improving
decision making. On the one hand, there is education and that
effort has continued. The Federal Reserve is continuing its
efforts toward promoting financial literacy and economic
education. I have an upcoming meeting with teachers across the
country, and I will be talking about financial literacy and
answering their questions and talking about how to introduce
students to these topics.
Some of the activities that we had have moved over to the
CFPB, which some personnel and some functions went over there,
but they are also engaged in those activities. So education is
one side.
On the other side, it is important that disclosures and the
types of products that are offered are such that people have a
reasonable chance of understanding what it is that they are
buying or investing in. The Federal Reserve pioneered a few
years ago the use of consumer testing to improve disclosures
for credit card statements and a variety of other types of
disclosures, and we hope to see that type of activity continue.
I think in general that the experience of the crisis has
made many people more aware of the need to be financially
literate, schools more aware, and more cautious as well. But it
is an ongoing battle. We cannot declare victory. We have to
continue to work to try to make sure that both kids in school
and also adults who are making financial decisions have access
to good advice and good education.
Senator Akaka. Thank you very much for your responses, Mr.
Chairman.
Chairman Johnson. Senator Johanns.
Senator Johanns. Mr. Chairman, good to see you again.
The forecasts that you have testified about today I am
assuming do not factor in the results of the fiscal cliff that
is headed our way between now and the end of the year. Is that
a safe assumption?
Mr. Bernanke. That is correct.
Senator Johanns. So because of the fact that all of the
various items that are included in the so-called fiscal cliff
would take affirmative action by Congress to pull us back,
which typically means 60 votes in the Senate, a majority in the
House, a Presidential signature, my assumption is that if that
does not happen, we get caught in a situation where those
forecasts would be revised yet again, and it would be even more
pessimistic than your testimony today. Would that be correct?
Mr. Bernanke. Absolutely.
Senator Johanns. As you think about the sequester, the $1
trillion sequester, as you think about returning to the 2001,
2003 tax policy, as you think about the estate tax and all of
the various factors that we are looking at between now and the
end of the year, if you were to give a recommendation to
Congress as to where to act, would it be act on everything or
is there a priority that you would set for action?
Mr. Bernanke. No. I think the choice is between spending
and taxes, and the mix and the kinds of taxes and so on, I
think that is really a congressional responsibility. I am just
pointing to the collective impact of all these different things
happening at the same time, and there may be many different
ways to mitigate that effect, and I am sure Members of Congress
have different views on the best way to do that, which is one
of the problems, because you are going to have to come to some
kind of agreement.
So, no, I do not have a specific recommendation other than
to think about not just the individual policies but their
collective impact if they all happen at the same time.
Senator Johanns. Let me talk to you a little bit about the
mitigation piece of this. As you know, some of us--in fact,
some of us on this Banking Committee--have been meeting for
many, many months--in fact, for some members they have been
meeting for over a year--talking about an approach, and I would
guess the best way of describing that is the outline for the
approach is the Simpson-Bowles plan, which came out a year ago.
Thinking about that plan, would you be comfortable in
testifying today that that at least is an acceptable
alternative to what we are facing between now and the end of
the year if Congress could see its way to adopting that
approach?
Mr. Bernanke. Well, it does have a profile that seems
reasonable in terms of addressing longer-term sustainability
over the longer period. But, again, I do not want to endorse
the individual components, in part because, again, choices
between taxes and spending are a congressional prerogative, and
also because the Bowles-Simpson plan is not really a complete
plan. It does not, for example, say very much about health care
and how those costs will be controlled, but it does have the
feature that, like many other plans that have been suggested--
and there are others, Rivlin and others as well--introduce this
discipline, fiscal discipline, in a rigorous way but over a
longer period of time to allow the economy to adjust more
easily.
Senator Johanns. You know, Mr. Chairman, I think if the
average citizen were to listen in on the political debate that
will occur between now and November--and political debate is
certainly appropriate; that is how democracies work--you would
get very discouraged. But having said that, give us your
thoughts. If Congress were able to put a plan in place, whether
it is Bowles-Simpson or another approach, that provided that
stimulus maybe for a period of time--in my judgment, pull back
on the sequester--provided economic stability in terms of tax
policy and revenue policy and started stabilizing things with a
view toward trying to deal with the deficit over a period of
time, what kind of signal would that send to the marketplace?
And do you think that would be a positive signal?
Mr. Bernanke. It would be very positive. It would reduce a
lot of the uncertainty that we see. It would address a very
important problem, and it would show the ability of our
political system to deliver important results.
You may recall that when the U.S. Government was downgraded
last summer, the putative reason was the concern about the
ability of Congress to come to a solution, not a lack of
resources for the country as a whole, but it really was this
issue about whether the Congress can work together to deliver a
satisfactory outcome.
So I think something like that, even if it was only an
outline, you know, a set of guidelines or guideposts that
Congress would fill in as it went forward, I think that would
go a long way to reducing uncertainty, increasing confidence,
and addressing one of our biggest longer-term problems.
Senator Johanns. Thank you, Mr. Chairman.
Chairman Johnson. Senator Brown.
Senator Brown. Thank you, Mr. Chairman.
Chairman Bernanke, nice to see you. As you know, as a
result of Dodd-Frank, the Federal Reserve has gained a great
deal more authority to oversee U.S. banks. Regulators, we know,
all of us agree bipartisanly, have a responsibility to ensure
that firm rules are in place, that rules are being followed,
that bad actors are being punished. Unfortunately, as we all
know and read day after day after day, since 2008 we have seen
too many examples of Wall Street again breaking rules and laws
and common standards of ethical behavior. I follow up on some
issues that Senator Vitter talked about, and I want to just run
through it for the sake of repetition because it is so
important to continue to recognize what these problems are:
investor lawsuits; SEC enforcement actions over mortgage-backed
securities; municipalities sold overpriced credit derivatives,
bankrupting some of them; five of the Nation's largest
servicers found to have forged foreclosure documents and
mortgage security legal documents.
The Nation's largest bank in January halted all consumer
debt collection lawsuits over concerns about poorly maintained
and inaccurate paperwork; the Nation's largest bank has lost
$5.8 billion to date on large, complex derivative trades the
regulators either did not know about or looked the other way;
it appears their employees misreported losses; 16 global banks
are suspected of manipulating LIBOR that is used as a benchmark
for mortgages and credit cards and student loans and, as you
know, even derivatives.
In June, one publication reported on a criminal bid-rigging
trial exposing illegal practices by many Wall Street banks and
arranging bids so that banks could underpay for municipal
bonds.
Two weeks ago, former employees of the Nation's largest
bank told the New York Times the company urged them to steer
clients to their own mutual funds because they were more
profitable for the bank even though they paid investors lower
returns than other funds.
The Federal Energy Regulatory Commission is investigating
whether the biggest U.S. bank manipulated prices in the energy
market.
I mean, this goes on and on and on and on, not to mention
wrongdoing in institutions over which the Fed has no
jurisdiction: MF Global, PFG Best, the problematic Facebook
IPO, recent reports that analysts at Wall Street's biggest
banks are sharing secret information.
No wonder the public does not trust you or us or any of the
banks--whether the banks on Wall Street, the bank regulatory
system. So I do not know any other answer, Mr. Chairman, other
than to put out there and again say I think so many of our
biggest banks are too big to manage and too big to regulate. I
think this behavior shows they are too big to manage and too
big to regulate. True?
Mr. Bernanke. There have been many bad practices, I agree.
Many of them were tied to the crisis period, a period of
excess. I think that is bad business. I think it is important
for us to address those issues through enforcement. And, of
course, part of the reason--I am not overclaiming here, but
part of the reason you could make such a long list is that so
many of these things have been turned up by various
enforcement----
Senator Brown. And perhaps many have not.
Mr. Bernanke. Perhaps many have not, that is true. On----
Senator Brown. Well, Mr. Chairman--and I apologize for
interrupting. It is not really fair. But you said this is bad
business. Well, for a lot of them, it has been kind of good
business. It has been a way for--it has been embarrassing to
some, but it has also meant bigger and bigger profits and
bigger and bigger bonuses. And to say it is bad business, from
an academic viewpoint, from a perch at Princeton perhaps, but
it is not good for our economy, but there have been far too
many rewards for some of the bad actors.
Mr. Bernanke. It is very shortsighted. It is not the way
you build a long-term relationship with customers and not the
way you have long-term profits.
On the size of banks, I think the real issue is too big to
fail. If you conquer too big to fail, then there will be strong
market pressures for banks that are too big to manage, too big
to operate, to break up. There was a story about that in the
media this morning about the benefits of providing shareholders
with additional value by breaking up in situations where you do
not have good controls and you do not have good synergies
between different parts of the bank.
And so what Dodd-Frank does is it provides a blueprint for
attacking too big to fail, and that includes the liquidation
authority, it includes the living wills--which, by the way, do
provide a blueprint. If you wanted to break up banks or hive
off parts of banks, the living wills provide some information
about, you know, how you would do that in a sensible way.
So I think it is very important to attack too big to fail,
and we are addressing that through capital, through
supervision, through orderly liquidation authorities, through
living wills. And I think if banks are really exposed to the
discipline of the market, we will see some breakups of banks.
Senator Brown. Living wills seem to take effect, at least
in the nonfinancial world, only close to somebody's deathbed,
and I do not think these living wills address the issue, nor
does this other regulation--other kinds of regulations seem to
address the issues of all this litany of problems I mentioned.
In the end, if these banks can be regulated, then it seems
clear to me that the Fed and other regulators--that includes
the far too often captured by the regulators OCC--that they are
either not up to the job, or they are complicit in Wall
Street's activities. I guess I beg of you to figure out how we
are going to restore the confidence of the American people in
the financial markets, because we certainly have not yet.
Mr. Bernanke. That is a high priority. I agree.
Senator Brown. Thank you.
Chairman Johnson. Senator Toomey.
Senator Toomey. Thank you, Mr. Chairman, and thank you,
Chairman Bernanke, for being here. I just want to touch briefly
on monetary policy before moving on to the LIBOR scandal.
Mr. Chairman, you acknowledged that there is a range of
views about the efficacy of the policy that you have been
pursuing. I am sure you would also acknowledge that there is a
range of views about the risks that are associated with the
policies you have been pursuing. And I will acknowledge that I
am sympathetic to the fact that we have given you a dual
mandate, which I think intrinsically creates the risk that you
will be put in a position where you have to deal with the
conflict over two conflicting goals.
But I just want to stress--and I know you and I disagree on
this. We have had this conversation. But I just feel strongly
that the problems facing our economy are not monetary in
nature. They result from this ongoing deleveraging process that
we are suffering through, a regulatory avalanche, completely
unsustainable fiscal policy, which you have acknowledged, and
the threat of huge tax increases. And so to address this with
ever easier monetary policy, I worry very much about the
unintended consequences, including the fact that it has the
effect of masking the true cost of these deficits and making it
easier for us to continue this very imprudent fiscal policy.
So I just want to reiterate that point, but what I would
like to ask you about, if I could, is this LIBOR scandal. And I
will tell you I am very disturbed about this. I am disturbed
about the destruction of what little confidence might remain in
our financial system. I am very concerned about the direct
impact to American citizens, including my constituents, among
many. I think of the city of Bethlehem that engaged in interest
rate swaps where they were paying a fixed rate, receiving
floating rates based on LIBOR, and I wonder whether they were
systematically receiving payments that were lower than what
they should have gotten because of this.
You had mentioned in your testimony or perhaps in answer to
a question that Fed officials became aware of Barclays'
manipulating this index in April of 2008. The Wall Street
Journal has an editorial today in which they recount an email
exchange that occurred in August of 2007 between--or perhaps it
was a phone conversation between a Barclays employee and a Fed
official.
I am just wondering. When did you become aware that there
was some lack of integrity in the report of LIBOR rates?
Mr. Bernanke. So on your first point, let me just say that
there is not as much disagreement as you imply. Monetary policy
is not a panacea. It is not the ideal tool in many cases, and
we look forward to having partnerships with other parts of
economic policy.
On the telephone contacts, I would just note that these
were phone calls, and these were calls made by junior employees
whose job was to call and get so-called market color, get
information about what was happening in the markets. And I
think in one of those calls it was clear that the person
calling the Fed employee--not an official, the Fed employee--
did not know what LIBOR was or how it was constructed, and so
there were some issues about how that was communicated.
In any case, I learned about it, to my recollection, at the
time when it became covered in the media, which would have
been, I guess, in April 2008.
Senator Toomey. OK. Here is what I do not understand. I
know you fully appreciate the importance of this index, how
widely used it is for all kinds of transactions and how the
American financial system--I do not want to say it is dependent
on it, but it is totally integrated into this. And you and many
other regulators understood that there were serious questions
about the integrity of this, perhaps even systemic problems
with the integrity of this, and yet everybody allowed these
transactions to continue. Did it not occur to somebody to bring
the financial institutions together and say, hey, you probably
ought to consider a different way of establishing your floating
rate resets because there is this integrity problem? Did that
conversation happen with any financial institutions or the
public?
Mr. Bernanke. Well, financial institutions are not the only
participants in this LIBOR-based market.
Senator Toomey. OK. Yes, how about making it more broad?
Mr. Bernanke. So I think the best way to address the
problem and given all the issues that were occurring during the
crisis at that point in time, the best way to address the
problem, at least in the near term, would be to reform the way
those numbers were collected so that the LIBOR rate that was
set would be, in fact, an accurate representation.
Senator Toomey. I agree. My question, though--and you
mentioned observable market transactions would seem like a
better way of doing it than a survey of banks. That sounds
sensible to me. The question is: Why have we allowed it to go
on the old way when we knew it was flawed for the last 4 years,
with trillions of dollars of transactions?
Mr. Bernanke. Because the Federal Reserve has no ability to
change it.
Senator Toomey. You have enormous influence over the
institutions engaging in this.
Mr. Bernanke. We have been in communication with the
British Bankers Association. They made some changes, but not as
much as we would like. It is not that market participants do
not understand how this thing is collected. It is a freely
chosen rate. We were uncomfortable with it. We have talked to
the Bank of England.
Senator Toomey. But I am not sure that market participants
were aware of the problem with the integrity of the mechanism
by which it is established. And as you point out, there are
other ways you could establish a perfectly viable floating rate
that would not have these problems. I am just very surprised
that this was allowed to continue for so long when the problem
with the integrity was known.
Mr. Bernanke. Well, again, Senator, the New York Fed took
the lead in making, I think, some very good suggestions about
how to clean up the LIBOR process.
Senator Toomey. Thank you.
Chairman Johnson. Senator Kohl.
Senator Kohl. Chairman Bernanke, last July we discussed how
the United States is experiencing a jobless recovery. You
agreed then that the long-term unemployment was a major problem
and recommended that Congress take a look at ways to help the
unemployed through things like training and education. Of
course, the Federal Reserve has its own mandate to keep
unemployment low, and we continue to see very disappointing
jobs numbers.
I am sure we agree that the consequences of long-term
unemployment are enormous. So why has the Fed been so slow to
tackle unemployment? Over the past year, why hasn't the Fed
issued a third round of quantitative easing? And could you
expand on your current maturity extension program?
Mr. Bernanke. Certainly. So first, just briefly, of course,
we have taken a wide range of extraordinary actions to support
the economy. In June, we took the step of continuing the
maturity extension program, which has many of the features of
quantitative easing in that it involves purchases of longer-
term securities which provides financial accommodation and
additional support to the economy. And we made clear that we
were prepared to take further actions, and we are looking to
see if we are going to get sustainable improvements in labor
markets. If we are not getting sustainable improvements, we
will have to seriously consider taking additional action.
The reason that there is any question is really, again, the
range of views about efficacy, costs, and risks associated with
these nonconventional measures. But that being said, as we said
in June, we are prepared to take further action, and we will
evaluate our options as we go forward.
Senator Kohl. I appreciate that. However, given that
unemployment has remained over 8 percent for 41 months, a long
enough time for it to be clear, now is the time to be more
aggressive, I believe, in your approach to unemployment. And I
think we agree the consequences of long-term unemployment are
too great for this to go on very much longer.
On LIBOR, Mr. Bernanke, one chief executive of a
multinational bank was quoted in The Economist as saying that
LIBOR is ``the banking industry's tobacco moment,'' citing the
1998 federally negotiated settlement that cost American tobacco
companies over $200 billion.
Can you foresee a scenario where banks would seek any type
of taxpayer assistance in order to compensate parties that were
victims of LIBOR rigging? Do you believe that potential court
cases against banks that participated in LIBOR manipulation
could indeed result in another federally negotiated settlement?
Mr. Bernanke. Well, there are many court cases already in
progress. I think it is too soon to make any guess at what the
outcome of those courts' cases will be. There have been a few
estimates by private analysts of potential costs, but those are
admittedly very much back-of-the-envelope types of
calculations. So I think we have to let this play out. I do not
know what the cost will be, and I really do not think is
responsible for me to guess until we get more information about
the impact of these actions on the actual LIBOR rate and the
implications of that for rates that people paid.
So it is obviously very serious, but I think it is too
early to judge what the costs will be.
Senator Kohl. Yes, and recent press reports indicate that
the scandal could cost the banking industry millions, if not
trillions of dollars. And as you know, there is no appetite
here or anywhere else to do another bailout for the banks.
Given the increasing amount of money that is at stake, I would
urge you to work, when the time comes, closely with the Justice
Department on this, and I think you would agree that you will.
Mr. Bernanke. If we can contribute to a global settlement,
as we did in the case of the servicers, we would, of course.
Senator Kohl. Thank you.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Moran.
Senator Moran. Mr. Chairman, thank you. Chairman Bernanke,
thank you for your testimony.
In advance of the crisis, the financial crisis of 2008, at
least to many observers of our country's economy, it came out
of the blue, came as a surprise. What is it that you are
worried about now? What is out there now that we ought to be
paying attention to that has the potential of being the next
crisis to the economy of the United States? I often read about
credit card debt. You read about student loan debt. What are
the things that you are most worried about? And what are we
doing to remediate the problem?
Mr. Bernanke. Well, I think the two items--and I mentioned
these in my testimony--would first be the European sovereign
and banking situation, which remains unresolved. There is still
a lot of financial stress associated with that and I think
still some distance before they get to a solution. That poses
an ongoing drag on our economy, and although I have every hope
and expectation that European leaders will find solutions,
there is the risk of a more serious financial blowup. And we
have been--I do not want to take all your time, but we have
been taking appropriate steps here in the United States to try
to strengthen our banks and provide--to prepare for whatever
events might occur.
The other, just briefly, is the domestic fiscal situation
which we have been talking about, and I think it is important
that in the short term Congress work effectively to address the
debt limit and the fiscal cliff and those issues and in the
medium term establish a strong, credible plan for fiscal
sustainability.
Senator Moran. At what point in time do we have a sense of
whether the European crisis is going to have huge consequences
to the U.S. economy? What timeframe are we on in which we know
whether Europe has appropriately responded to resolve their own
problem?
Mr. Bernanke. Well, we appear to be in a muddling-through
type of environment, which is costly to everybody, Europe even
more so than us. They are already in a recession, or at least
many countries in Europe are already in recession.
I think based on all I can observe, it seems like it could
take a very long time because the structural and institutional
changes that Europe is trying to make are not ones that take
place quickly. For example, they have recently agreed in
principle to create a single bank regulator for eurozone banks.
To do that could well take--I do not have any inside
information here, but obviously it could take some time--it
could go into next year--before they have a single bank
regulator.
Likewise, they are trying to establish a set of fiscal
rules and fiscal agreements, and they have made some progress
there. But given that there are 17 Governments that have to
agree to every major change, it could be some time before they
come to a fully satisfactory fiscal arrangement.
So it appears to be something that could go on for quite a
while, unfortunately.
Senator Moran. Let me ask a more specific question, a more
narrow question. The Kaufmann Foundation is a foundation in
Kansas City that considers entrepreneurship, and its facts, it
studies demonstrate that between 1980 and 2005, companies that
are less than 5 years old accounted for nearly all of the net
new jobs created in the U.S. economy. In fact, new businesses
create an average of 3 million jobs each year.
Unfortunately, our own Census Bureau now indicates that the
startup engine is engine is slowing down. In 2010, there were
about 394,000 new businesses started in the United States. This
is the lowest level of new startups since 1977.
I would like to hear your perspective on the importance of
startups and what policies Congress and the administration
should pursue to return to the days in which the United States
is at the forefront of innovation and entrepreneurship.
Mr. Bernanke. Well, those facts I believe are correct.
Young companies, so-called gazelles, are a big contributor to
job creation because if they are successful, they grow quickly,
and they add a lot of employees. I do not know the data you
cited; I do not know how accurate they are. It is obviously
very difficult to measure startups. Many of them are very small
enterprises. But I think it is clear that both because of the
weak economic conditions but also because of problems relating,
for example, to the availability of credit and venture capital
and the fact that many entrepreneurs use equity in their home
as a form of startup capital, which is not as available now as
it was before the crisis, it is very plausible that those
companies are not starting up at the rate they have in the
past.
I do not have a really good program here to suggest other
than to try to create as favorable a tax environment, as
favorable a credit environment as possible for startup firms,
to write regulations in a way that serves their purpose but
allows small firms to flourish.
According to international agencies who calculate these
sorts of things, the U.S. has got a pretty small business
friendly environment here in terms of the cost and time
required to startup a small business. So it is not like we are
in very bad shape on that. But any kind of improvement that
would make it easier for small businesses to get the necessary
capital to meet the regulatory and other requirements and to
avoid early tax burdens, all those things are obviously
approaches that can help these companies startup and provide
employment.
Senator Moran. Mr. Chairman, thank you. One would think
that we would have significant startups, particularly in light
of the unemployment numbers, which creates the opportunity or
the necessity for someone to go startup a business on their
own.
Mr. Bernanke. Sure.
Senator Moran. Mr. Chairman, thank you.
Chairman Johnson. Senator Warner.
Senator Warner. Thank you, Mr. Chairman. And, Mr. Chairman,
the end is near. Thank you for hanging in this morning. I would
echo what my colleague Senator Moran just said. We actually
have legislation to try to promote these startup activities,
Startup Act 2.0, which addresses the very issues you talked
about as well as the issue of talent. We are in a global
competition for talent, and I commend Senator Moran's
leadership on this issue. We did make some movement on access
to capital earlier.
I know most of my colleagues have left, but I would also
point out for some of my colleagues that because of the actions
we took as this Congress in Dodd-Frank and otherwise, we have
seen an increase in capital in American banks in excess of $300
billion, more in capital reserves, since the crisis, and
clearly I think that has helped our banking industry relative
to some of the banks that are under assault around the world.
I also want to commend you for your continuing urging of us
to act on fiscal policies. Waiting for Congress is a little bit
like waiting for Godot. Hopefully we will see some actions
later this year, and a number of us have been working on this.
I guess one of the things I--my first question would be: As
we grapple with this issue of trying to get an appropriate
balance of revenues and entitlement reform to generate at least
that $4 trillion, to drive our debt-to-GDP back down, and
because, as you have pointed out, we can do this on a
moderate--an intermediate basis and have the ability to phase
these things in, I sometimes scratch my head, because what is
being asked of the American people is so much smaller than what
is being asked of the folks within the U.K. or folks within
Europe or even folks in India and elsewhere where they are
going through policy changes. Have you done any kind of sizing
of what a $4 trillion deal relative to the size of our economy
and the ask of the American people versus what is being asked
of folks all around the rest of the world as they try to move
forward and get their own fiscal houses in order?
Mr. Bernanke. Well, I have not done that exercise exactly,
but in terms of percentage of GDP, you know, some of the fiscal
shifts that are taking place in countries like Spain, Portugal,
and Italy are very substantial and in the near term, which is
part of the reason why their economies are so weak in the near
term. So it is certainly true in terms of the fiscal step that
is being taken that it is larger in these countries which are
under fiscal stress. But I am not quite sure what the
implication of that is. We are lucky that we can borrow at a
very low interest rate. We are not currently in the same
situation as a Greece or a Portugal. And, therefore, if we can
intelligently combine a gradual glide path with a strong,
credible plan for stabilizing our deficits in the longer term,
we can avoid that kind of painful contraction and do it more
gradually.
Senator Warner. It almost seems to me that it is
remarkable--and I think this is why Congress is at record low
levels of approval--that we cannot step up, almost un-American
that we cannot do our job relative to what is being asked of
other people around the world.
One of the things that--I know we have had some policy
debate this morning on, additional actions you might take to
stimulate the economy. I guess one question I would say for
those who have questioned taking these actions, if we look at
the European Central Bank's recent actions in terms of--if we
look at the Bank of England, if we look at the Chinese
financial institutions, what effect of their stimulus
activities or loosening activities does that have on the world
economy and in terms of your decision making?
Mr. Bernanke. Well, there has been a global slowdown. A lot
of it is emanating from Europe, which through export demand is
affecting Asia and other parts of the world, the United States
as well. There has been some slowing in Asia as well. The
Chinese GDP statistics have been weaker this year than in
previous years. Partly that was intentional as they sought to
cool their housing market and address inflation concerns.
But there is a slowing in the global economy. To the extent
that actions taken by our trading partners strengthen those
economies, it will help us on the margin because it will
increase our markets and provide an overall better economic
environment.
But I would say at this point that compared to what we saw
during the aftermath of the crisis, nothing is happening
globally of that kind of scale. There are relatively modest
steps being taken in both of those jurisdictions to try to
offset some of the slowing.
Senator Warner. But those actions are similar to what you
may take in the Fed, and I guess the point I would simply make
is that there seems to be a consensus opinion around major
economies around the world to take these type of stimulative
actions.
Mr. Bernanke. The world is in an easing cycle. That is
correct. And in terms of the specific actions, the U.K., for
example, has been adding to its quantitative easing program and
doing other things as well. So the U.S. is--it should be very
clear the United States--the Federal Reserve is not the only
central bank that has been using these unconventional policies
as a tool for trying to strengthen their economies.
Senator Warner. Thank you, Mr. Chairman.
Chairman Johnson. Senator Wicker.
Senator Wicker. Thank you very much. And, Chairman
Bernanke, thank you so much for being here. I have been back in
my office listening to most of this on television.
I appreciate the fact that you have talked about fiscal
policy as well as monetary policy and the overall economy. You
note that your forecast is lower than it was back in January,
and you say that you now forecast that we will have over 7
percent unemployment on through the end of 2014. I think we
would all agree this is not the kind of economic growth that we
need and that Americans have had in the past.
If taxes are raised on individuals making over $250,000,
many of whom are small business people, many of whom are job
creators, what effect will that have on the projection that you
have in your written testimony?
Mr. Bernanke. Well, we have not done that specific
exercise. I have been focusing on the overall size of the
fiscal shock. That includes the expiration of all the 2001 and
2003 tax cuts as well as the end of the payroll tax cut, UI
payments, and the sequestration. You put all those things
together, and you get a shock which is about 4.5 percent of
GDP.
Senator Wicker. OK. Because the President came out and
reiterated last week his request that we simply raise taxes on
$250,000 and above. I think you will agree that in terms of the
Federal deficit, that is a relatively small amount. That would
be a tax on job creators and would make your numbers worse,
wouldn't it?
Mr. Bernanke. It could, if it reduced incentives and if it
reduced aggregate demand, both of those channels. But as often
is the case in tax policy, you have got efficiency and growth
concerns, and you have also got equity concerns, and all those
things feed into tax decisions.
Senator Wicker. I realize it is hard to predict with
certainty, and I think we have seen that over time. But I would
simply suggest to you that you are correct in saying that it
could have an adverse effect.
Let me ask you about the fiscal shock. I think we have got
to do something on the spending side, and I know what you are
saying. The economy is fragile, and you do not want it to
happen quite so quickly.
Senator Kyl and Senator McCain came up with a proposal to
dealing with sequestration, and let me just ask you--it went
over like a lead balloon, but let me go back to it and ask you
what your general impression is of the proposal. It would have
raised--it would have saved, rather, $127 billion in spending
by simply doing two things:
Number one, freezing Federal pay for Federal workers until
June of 2014. That would be the first thing.
The second thing would have been a 5-percent reduction in
the Federal workforce--not a 5-percent reduction in Federal
spending but a 5-percent reduction in the Federal workforce--by
hiring only two workers to replace every three that are leaving
through attrition. And this reduction would have taken up to 10
years to achieve.
That is not the sort of thing that you view as a fiscal
shock, is it? We could absorb that type of modest spending
reduction in order to save us from the meat axe approach of
sequestration at the end of this year.
Mr. Bernanke. Well, again, without endorsing the specific
program, a spending program that comes in more gradually over a
period of time but also is tied to a plan, a credible plan to
achieve fiscal sustainability in the medium term is what I am
recommending, is something that would avoid this very, very
sharp change in the Government's fiscal position, you know, on
1 day, on January 1, 2013.
Senator Wicker. Let me see if I can squeeze in one more
thing. Unemployment rates, unacceptably high, and you have
predicted now 7 percent of more by the end of 2014.
In January of 2002, unemployment rate 5.7 percent; October
of 2003, unemployment rate 6 percent; by October of 2004 down
to 5.5 percent. Boy, wouldn't we love to see that kind of
unemployment right now in the United States of America. Down to
4.9 percent by August of 2005; 4.4 percent unemployment rate--
these are actual figures--by October of 2006; as late as May of
2007, unemployment rate 4.4 percent; and then, of course, by
the end of 2008, it is up to 7.3 percent.
We hear a lot of discussion and a lot of warnings by people
in this city about not going back to those disastrous policies
that got us into the situation we are in in the first place.
The fact is we had relatively low and a relatively acceptable
unemployment rate for much of the decade until 2008, and we had
real GDP growth in 2006, 2007, and 2008. Isn't that correct?
Mr. Bernanke. Until the end of 2008, yes.
Senator Wicker. Now, what happened in 2008? Was it tax cuts
for the rich?
Mr. Bernanke. No. We had a major financial crisis, as you
know, and it created a global recession.
Senator Wicker. Right.
Mr. Bernanke. A very deep one.
Senator Wicker. Thank you very much.
Chairman Johnson. Senator Merkley.
Senator Merkley. Thank you, Mr. Chair, and thank you,
Chairman. In your opening comments, you mentioned the issue of
housing refinancing and families that are underwater. We have
about 8 million families whose mortgages are underwater. Some
can refinance through HARP, but it has been a pretty small
number, only about 200,000 so far, in part because of the
complexity with second mortgages. But if families who are
underwater could refinance from those higher interest rates
they are trapped in to lower interest rates, could that be a
significant factor and a substantial tool, if you will, in
helping to move the construction economy forward and
stabilizing those 8 million families?
Mr. Bernanke. If that were possible, it would be helpful
because it would both reduce payments and, therefore, reduce
defaults and foreclosures, and it would improve the income of
the people who could refinance.
Senator Merkley. Thank you, Mr. Chairman.
Let me switch to another comment I believe you made in
response to Chairman Johnson, and I did not catch the exact
words, but I think you said you had emails about fixing the
interest rates to make the banks look more healthy, but we did
not have emails related to collusion with derivative traders,
or something like that. Could you help clarify what you said
there?
Mr. Bernanke. Yes. There have been two somewhat different
types of violations: one which was very much intense--that was
most intense during the crisis was banks underreporting the
cost of their borrowing in order to avoid looking weak in the
market. That is the kind of information that people were
talking about in the markets and that the New York Fed heard
about in 2008.
The other kind of activity is the kind that the
investigations have just recently revealed in the case of
Barclays involved this very large fine where there was clear
evidence of individual traders conspiring with others to
manipulate the LIBOR submissions in order to improve or
increase their profits from short-term derivatives trades. That
is a different type--I am not making a judgment but just a
different activity. And I was only making the point that it was
only the former that came to the attention of the New York Fed.
Senator Merkley. And so in terms of the latter, the
collaboration between the traders and those who were reporting
the LIBOR rates, when did that first come to the attention of
the Fed?
Mr. Bernanke. Not until relatively recently. This was
something that was discovered by the joint investigation of the
CFTC, I think the SEC was involved, the DOJ, and the British
authorities.
Senator Merkley. Thank you. It was very stark to read some
of these emails that were reported, such as, ``Hi, Mate. We
have an unbelievably large set on Monday. We need a really low
3-month fix. It could potentially cost a fortune.'' Or another
trader who wrote, ``We need a 4.17 fix on the 1-month low fix.
We need a''--the print is a little small for me--``4.41 fix on
the 3-month high fix.'' And certainly this type of activity,
does this constitute fraud? Does this fall into a criminal area
as well as just really unacceptable manipulation, if you will?
Mr. Bernanke. Based on what I know about it. What I have
read about it, it does seem to be so, yes.
Senator Merkley. I think the point that my colleague
Senator DeMint was making earlier was when you know that
someone has a thumb on the scale, isn't there a responsibility
to alert the customers about that thumb being on the scale? I
know that you all did send this advice to the Bank of England
or to others that there are ways to fix the thumb on the scale,
get the thumb off the scale. But if you had it to do over
again, would you also be alerting the customers, the
municipalities that are making swaps, the folks who are getting
mortgages based on LIBOR and so forth that something is not
quite right here and you should be aware of our concerns?
Mr. Bernanke. Well, it is important that people know about
it, but I am not sure I would agree that this was something
that was unknown. The financial press was full of stories about
it, and the reform proposals that the New York Fed made were
also reported in the press. So I think that there was a good
bit of knowledge, at least among more sophisticated investors,
about this problem.
Senator Merkley. I do think the municipalities that were
involved are feeling that perhaps they were not as aware of the
thumb on the scale as they might have been, but that will all
be, I guess, sorted out in due course.
Mr. Bernanke. That is right.
Senator Merkley. If my colleague will just bear with me for
30 seconds, I just want to mention an issue I will follow up
with you on, which is related to the growing role of banks in
providing crude oil to refineries and then buying the products.
We have Goldman that is doing this with a refinery operating in
three States. JPMorgan is doing it with the largest east coast
supplier. Morgan Stanley is now doing it in several States with
PBF Energy. It reminds me a little bit of the situation when--
and at this point there is no sign of wrongdoing of any kind,
but it reminds me of the potential for problems that occurred
when Enron was both supplying electricity and running
electricity trading markets, because we have that here. We have
now the banks involved as a supplier and purchaser of large
quantities, but we also have them involved in all kinds of
trading, in part because at this point regulators have exempted
the spot markets, or at least the draft rules, from the Volcker
firewall.
Is this an issue that we should be concerned about, this
substantial conflict of interest of being a supplier and also
kind of, if you will, involved in the trading side?
Mr. Bernanke. Am I mistaken, Senator? I thought that the
statute exempted the spot market as opposed to the regulation.
Senator Merkley. Let us follow up on that.
Mr. Bernanke. Let us follow up on that.
Senator Merkley. Let us follow up on that because there is
also a lot of letters that have been submitted on the futures
spot markets, if you will, not futures themselves. The
``forward'' I think is the right term.
Mr. Bernanke. Correct.
Senator Merkley. And I believe that that is a gray area.
Mr. Bernanke. Well, except insofar as the statute exempts
certain activities, I assume that proprietary trading in this
area would be subject to the Volcker rule.
Senator Merkley. The spot is not excluded in the statute.
It does give regulators authority over that.
Mr. Bernanke. All right. We will look at that.
Senator Merkley. OK. Thank you.
Chairman Johnson. Senator Bennet.
Senator Bennet. Thank you, Mr. Chairman. Sorry. One would
have thought I could have gotten the frog out of my throat 2
hours into this hearing.
Mr. Chairman, thank you for being here, and thank you for
your testimony. I want to make one observation, and then I have
got a couple of questions, because there have been traces of a
discussion in here today about the nature of the economic
growth we need to see in this country, and it really is not
just about GDP growth. It is about job growth and wage growth
in the United States and whether we can recouple those things
together. They decoupled in the last recovery. They are not
coupled in this recovery. And as you observed, there are things
that we can do in our Tax Code and our regulatory code and our
statutes that actually would provide an ecosystem that would
deliver on that promise again for the American people.
We have been having a hard time getting to that
conversation in this Congress, but we need to. That is the
fundamental work, in my view, why we were sent here.
We spend a lot of time talking about how to avert crisis
now, and you are a historian of the Great Depression, I know,
and I think 100 years from now, if we do not get our act
together here, no historian will be able to fairly record your
tenure without saying that you came to the Senate and to the
Congress and you very clearly said, ``Here are the things I am
most worried about, and if you do not deal with it, you risk a
real disaster.'' One is Europe, which you talked a little bit
about. I would like to hear on that score a little more about
what you say in your testimony are the strong incentives to
resolve the crisis that the Europeans have. The IMF, as you
know, came out with a report yesterday about some of the
challenges they face.
Maybe I will start there. What are those strong incentives
to resolve the crisis? They have a lot of political dysfunction
there, as we do here, but they also have, as you pointed out, a
less elegant institutional arrangement right now for dealing
with it.
Mr. Bernanke. That is right. Well, they have both economic
and political incentives. The European Union and all those
European-wide institutions that include now the common currency
area were created after World War II in part to try to avoid
any future war on the European continent, and obviously that is
an extremely important objective that people put a lot of
weight on. And so closer political union is something that many
European leaders consider to be important, and so this is part
of--maintaining the currency and achieving stability there is
part of that.
In addition, both the North and the South, so to speak,
benefit from the common currency. In particular, for example,
the Germans have an exchange rate in the euro which is probably
weaker than they would have if they had a deutsche mark, and,
therefore, they have both a weaker currency, a more competitive
currency, and, if you will, a captive market for selling their
exports, both of which would not be there if the eurozone was
not an integrated, stable structure.
So even from the point of view of the Germans, who have,
you know, the most concern about the potential fiscal costs of
greater coordination within the eurozone, they have both very
substantial political and economic reasons to try to make this
happen, and throughout Europe, the general opinion polls in
most cases are that people would still rather have the euro,
despite all the problems that they have been facing.
Now, as you point out, there are many difficult political
problems. We have one Congress here, and we have difficulty
coming to decisions. They have 17.
Senator Bennet. I cannot even imagine.
Mr. Bernanke. They have 17 different parliaments, and they
have a treaty which requires broad if not unanimous agreement.
So there are some very substantial problems in getting to
agreement.
Senator Bennet. Let me, because I do not want the Senator
from North Carolina to have to wait on me. Let me come to the
second point, the stuff that is actually in our control. This
is your testimony today, [Page 45]. ``The most effective way
that the Congress could help to support the economy right now
would be to work to address the Nation's fiscal challenges in a
way that takes into account both the need for long-run
sustainability and the fragility of the recovery. Doing so
earlier rather than later would help reduce uncertainty and
boost household and business confidence.''
Tell us what that 100-year history would record if we do
not do this.
Mr. Bernanke. Well, in the short term----
Senator Bennet. And I mean short and medium and long.
Mr. Bernanke. Well, as I was saying as the CBO and others
have pointed out, if the fiscal cliff is allowed to happened,
as is now programmed in the law, it would probably knock the
recovery back into a recession and cost a lot of jobs and would
greatly delay the recovery that we are hoping to facilitate.
In the longer term, it is simply not possible for deficits
to continue along the path that they are currently projected,
so either some solution would have to be found that could be
very, very painful at some point in the future because of the
size of the cuts--we were talking about comparing us to Europe,
and some of the countries that are making very, very deep cuts
right now and how painful that is. Either we would have to have
those kinds of cuts, or we might face a financial crisis where
interest rates would rise, as we are seeing now in Europe, and
that would feed through to other interest rates, like mortgages
and other kinds of rates. And it would be very costly to our
economy.
So both in the short term and in the longer term, it is
important for us as a Nation to create a fiscal policy that
achieves both the short-term and long-term objectives.
Senator Bennet. I wish I had more time, but I will come
back to you with other questions.
Thank you, Mr. Chairman.
Chairman Johnson. Senator Hagan.
Senator Hagan. Thank you, Mr. Chairman. And you, Chairman
Bernanke, for enduring the long hearing today. I do want to say
thank you, too, for your great work and your sacrifice.
Mr. Bernanke. Thank you.
Senator Hagan. We have talked a lot about LIBOR today.
LIBOR, as I understand it, is simply a benchmark that lenders
voluntarily use to represent the cost of borrowing by large
banks. But there are alternative metrics. You mentioned in your
testimony that financial institutions could use alternative
benchmarks for loans and derivative contracts, such as
commercial paper rates, the Fed funds rates, and the yield on
U.S. Treasury.
Can you discuss some of these alternatives? What might be a
preferable benchmark?
Mr. Bernanke. Well, as you say, there have been a number of
different ones. One that has been considered is the so-called
general collateral repo rate. It is the rate at which
repurchase agreements are done. It has the advantage of being a
very thick market. A lot of trades take place, and trades take
place at a number of different maturities, which is also
important. So that would be a possibility that people are
considering.
Another possibility is the OIS rate, the so-called
overnight index swap rate, which is a measure of expected
central bank interest rates, essentially. It is like a measure
of--a market-based measure of the longer-term Federal funds
rate. And it has some advantages as well.
I think the main thing that distinguishes these rates, the
ones you mentioned, and the repo rate and others from LIBOR is,
of course, that there are observable transactions every day,
which means there is no ambiguity about what the rate is. And
there would not be any of these issues raised by the LIBOR
process that involve verifying whether the reported rates are
indeed accurate.
Senator Hagan. Could you see financial institutions
voluntarily adopting an alternate to LIBOR.
Mr. Bernanke. I suspect that it will be seriously
considered, unless, of course, measures are taken that restore
confidence in LIBOR. The problem is that, of course, we have
enormous amounts of existing contracts, not just derivatives
contracts but a variety of other kinds of loans and securities,
which are based on LIBOR. And until those negotiated away or
they expire, we have this huge legacy issue of LIBOR-based
financial contracts. So it might be--it is just like the QWERTY
typewriter. You know, it is not very efficient, but everybody
is used to it, so it is hard to change. You might have the same
phenomenon there. But if we are going to keep LIBOR, it is
important to make sure that it has the confidence of people in
the markets.
Senator Hagan. Thank you.
Chairman Bernanke, Section 941 of Dodd-Frank requires the
Federal Reserve Board of Governors, along with other Federal
agencies, to jointly prescribe regulations that require
securitizers to retain credit risk. The proposed rule was
issued in March of 2011, and the comment period was
subsequently extended.
Could you describe the role that the Federal Reserve Bank
of New York and its staff are playing in the drafting and
completion of that rule?
Mr. Bernanke. Well, we sometimes draw on reserve banks for
specialized expertise. For example, in securitization laws,
rules, we tried to look at existing arrangements for credit
risk retention for different types of markets, and people in
New York who deal with those markets on a regular basis would
be helpful in providing that kind of information.
But, of course, the responsibility for drawing up the
regulations and making the final determination lies with the
Board of Governors in Washington, and although we may use some
expertise from New York, it is a Board decision.
Senator Hagan. Thank you.
A last question. When discussing the nonstandard monetary
policy tools that the FOMC is currently implementing, you have
consistently said that the level of accommodation that the
economy is receiving is based on the total stock of outstanding
securities in your portfolio. In June, the FOMC announced that
it was taking steps to extend the maturity of its Treasury
portfolio rather than to expand its size or change its
composition.
Can you discuss why the FOMC would choose to extend the
maturity of its Treasury portfolio and not acquire additional
mortgage-backed securities which would have the added benefit
of supporting the housing sector?
Mr. Bernanke. Well, when we say that the stock is what
matters, we are referring to the stock of longer-term
securities specifically. And so what this is doing is replacing
very short-term securities with longer-term securities,
increasing our stock of longer-term securities, putting
downward pressure on longer-term interest rates, and by taking
duration risk out of the market, pushing investors into related
assets like corporate bonds and lowering the yields there as
well.
So this was an effective step, and it was a relatively
natural one since the previous program was just coming to an
end in June, so we extended it for 6 months. But we continue to
look at alternative approaches, including approaches that
involve buying MBS, and trying to assess both the efficacy,
costs, and risks of those programs as well as the outlook and
the extent to which we think we can get a better outcome in the
U.S. economy.
Senator Hagan. In the FOMC's last policy statement, the
Committee indicated that it was prepared to take additional
steps if it did not see a continued improvement in the labor
market. My question is: What would you describe as an
improvement in the labor market if the FOMC does not project
unemployment to fall much below the current levels before 2013?
Mr. Bernanke. Well, we would want to see unemployment going
down. We do not want to see it stuck.
Senator Hagan. Right. We all do.
Mr. Bernanke. We do not want to see it going up. We want to
see continued improvement. We had significant improvement
between the fall of 2011 and earlier this year. Lately, we have
been leveled out, and we would like to see the economy return
to a situation where we are making progress on unemployment.
Senator Hagan. What I think about each and every day.
Thank you, Mr. Chairman.
Chairman Johnson. Chairman Bernanke, I want to thank you
for your testimony today on the Fed's economic forecast and its
recent actions. Thank you.
Mr. Bernanke. Thank you.
Chairman Johnson. This hearing is adjourned.
[Whereupon, at 12:25 p.m., the hearing was adjourned.]
[Prepared statements, responses to written questions, and
additional material supplied for the record follow:]
PREPARED STATEMENT OF SENATOR RICHARD C. SHELBY
Thank you Mr. Chairman.
Today, we will hear Federal Reserve Chairman Bernanke testify on
monetary policy and the state of the U.S. economy.
Four years ago, President Obama campaigned on restoring economic
growth and job creation. Today, both remain too weak to produce a
meaningful recovery.
At less than 2 percent, economic growth appears to be stuck at an
anemic level.
In June, only 80,000 jobs were added to employer payrolls, not
enough to put a dent in the stubbornly high 8.2 percent unemployment
rate.
The Administration's policy of more spending, more taxes, and more
regulation has clearly impeded an economic recovery.
Dodd-Frank rulemaking, of which 63 percent is behind schedule, has
cast a dark cloud over the financial system, further chilling consumer
and business lending and holding back growth.
Housing recovery, too, has been hemmed in by the lack of a clear
plan to resolve Fannie Mae and Freddie Mac and to reduce the Federal
Government's 99 percent share of the market.
These policy failures are costly and compound the dangers already
brought on by our mounting fiscal problems.
Concerns of spillover from the European crisis remain front-and-
center in the U.S. economy, but Europe also serves as a warning of what
could happen if we do not change our own fiscal course.
There is no doubt that we face challenging times for our economy
and our prosperity as a Nation.
In response to the dismal economic forecast, Chairman Bernanke has
said that the Federal Reserve is ``prepared to take further steps if
necessary to promote sustainable growth and recovery in the labor
market.''
I hope that the Fed weighs carefully the medium- and long-term
consequences of further action.
Questions remain on the efficacy of additional so-called monetary
stimulus, and many wonder what tools the Fed has left to use.
The Federal funds rate has been at or near zero for almost 3\1/2\
years.
The Fed's balance sheet stands at over $2.9 trillion, almost
identical to its size a year ago when Chairman Bernanke delivered his
last Humphrey-Hawkins testimony. This is more than three times its pre-
crisis size.
The Fed has conducted two rounds of balance sheet expansions called
``Quantitative Easing'' and a maturity extension program called
``Operation Twist'' that the Fed announced will continue through the
end of the year.
Even members of the Federal Open Market Committee (FOMC) have their
doubts about this decision. Minutes from the June FOMC meeting indicate
that several members thought the impact of another round of Operation
Twist ``was likely to be modest.''
One may wonder if the downside risks outweigh the limited upside
benefit of continuing the program.
Some FOMC members even noted that it ``could lead to deterioration
in the functioning of the Treasury securities market.''
Considering the risks presented by the Fed's more unconventional
programs and the need to unwind the Fed's balance sheet without causing
major economic disruption, some have questioned the prudence of
undertaking a new program to provide monetary easing, especially when
there appears to be no clear exit strategy.
During last year's Humphrey-Hawkins hearing, I expressed concerns
over the lack of transparency of balance sheet operations.
The Fed has yet to disclose a plan on how it would reduce its
balance sheet holdings, which must be carefully done to avoid dire
outcomes like sparking inflation and eroding the dollar's value.
Because so much is at stake for the U.S. economy, the Fed as a
public entity has the responsibility to make as much information
available as possible on its actions and the risks they entail.
Some authorities think there is cause for concern. In its annual
report, the Bank of International Settlements laid out the risks
entailed with the worldwide expansion of central bank balance sheets
and their extended low interest rate policies.
Not only did the report conclude that such actions create ``longer-
term risks to [central banks'] credibility and operational
independence,'' but they ``may delay the return to a self-sustaining
recovery.''
I hope that Chairman Bernanke will reassure our financial markets
during his testimony of the Fed's credibility and independence, that
the actions the Fed takes will not hurt economic recovery.
Recent events have already shaken confidence in our financial
system.
In particular, the issue that bankers manipulated the London
Interbank Offered Rate (LIBOR) is one that must be fully examined by
this Committee.
LIBOR is an important interest rate benchmark. It affects nearly
every interest rate calculation for consumers, businesses, and banks
around the world.
While only one bank has admitted its involvement in the
manipulation of LIBOR so far, it has been widely reported that the U.S.
Department of Justice and regulators are building cases against other
banks involved in the LIBOR-fixing process.
The American people deserve answers to important questions about
the LIBOR manipulation.
For example, to what extent were consumers, business, and
municipalities harmed by the manipulation of LIBOR?
Which financial institutions were involved?
When did U.S. regulators, including the Fed, first learn about the
manipulation? What steps did the Fed take to restore integrity to the
LIBOR market?
Could the Fed or other regulators have done more to prevent it?
I hope that Chairman Bernanke can provide answers to these critical
questions in his testimony before us today. Thank you Mr. Chairman.
______
PREPARED STATEMENT OF BEN S. BERNANKE
Chairman, Board of Governors of the Federal Reserve System
July 17, 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 before turning to
monetary policy.
The Economic Outlook
The U.S. economy has continued to recover, but economic activity
appears to have decelerated somewhat during the first half of this
year. After rising at an annual rate of 2\1/2\ percent in the second
half of 2011, real gross domestic product (GDP) increased at a 2
percent pace in the first quarter of 2012, and available indicators
point to a still-smaller gain in the second quarter.
Conditions in the labor market improved during the latter part of
2011 and early this year, with the unemployment rate falling about a
percentage point over that period. However, after running at nearly
200,000 per month during the fourth and first quarters, the average
increase in payroll employment shrank to 75,000 per month during the
second quarter. Issues related to seasonal adjustment and the unusually
warm weather this past winter can account for a part, but only a part,
of this loss of momentum in job creation. At the same time, the jobless
rate has recently leveled out at just over 8 percent.
Household spending has continued to advance, but recent data
indicate a somewhat slower rate of growth in the second quarter.
Although declines in energy prices are now providing some support to
consumers' purchasing power, households remain concerned about their
employment and income prospects and their overall level of confidence
remains relatively low.
We have seen modest signs of improvement in housing. In part
because of historically low mortgage rates, both new and existing home
sales have been gradually trending upward since last summer, and some
measures of house prices have turned up in recent months. Construction
has increased, especially in the multifamily sector. Still, a number of
factors continue to impede progress in the housing market. On the
demand side, many would-be buyers are deterred by worries about their
own finances or about the economy more generally. Other prospective
homebuyers cannot obtain mortgages due to tight lending standards,
impaired creditworthiness, or because their current mortgages are
underwater--that is, they owe more than their homes are worth. On the
supply side, the large number of vacant homes, boosted by the ongoing
inflow of foreclosed properties, continues to divert demand from new
construction.
After posting strong gains over the second half of 2011 and into
the first quarter of 2012, manufacturing production has slowed in
recent months. Similarly, the rise in real business spending on
equipment and software appears to have decelerated from the double-
digit pace seen over the second half of 2011 to a more moderate rate of
growth over the first part of this year. Forward-looking indicators of
investment demand--such as surveys of business conditions and capital
spending plans--suggest further weakness ahead. In part, slowing growth
in production and capital investment appears to reflect economic
stresses in Europe, which, together with some cooling in the economies
of other trading partners, is restraining the demand for U.S. exports.
At the time of the June meeting of the Federal Open Market
Committee (FOMC), my colleagues and I projected that, under the
assumption of appropriate monetary policy, economic growth will likely
continue at a moderate pace over coming quarters and then pick up very
gradually. Specifically, our projections for growth in real GDP
prepared for the meeting had a central tendency of 1.9 to 2.4 percent
for this year and 2.2 to 2.8 percent for 2013. \1\ These forecasts are
lower than those we made in January, reflecting the generally
disappointing tone of the recent incoming data. \2\ In addition,
financial strains associated with the crisis in Europe have increased
since earlier in the year, which--as I already noted--are weighing on
both global and domestic economic activity. The recovery in the United
States continues to be held back by a number of other headwinds,
including still-tight borrowing conditions for some businesses and
households, and--as I will discuss in more detail shortly--the
restraining effects of fiscal policy and fiscal uncertainty. Moreover,
although the housing market has shown improvement, the contribution of
this sector to the recovery is less than has been typical of previous
recoveries. These headwinds should fade over time, allowing the economy
to grow somewhat more rapidly and the unemployment rate to decline
toward a more normal level. However, given that growth is projected to
be not much above the rate needed to absorb new entrants to the labor
force, the reduction in the unemployment rate seems likely to be
frustratingly slow. Indeed, the central tendency of participants'
forecasts now has the unemployment rate at 7 percent or higher at the
end of 2014.
---------------------------------------------------------------------------
\1\ See, table 1, ``Economic Projections of Federal Reserve Board
Members and Federal Reserve Bank Presidents, June 2012'', of the
Summary of Economic Projections, available at the Board of Governors of
the Federal Reserve System (2012), ``Federal Reserve Board and Federal
Open Market Committee Release Economic Projections from the June 19-20
FOMC Meeting'', press release, June 20, www.federalreserve.gov/
newsevents/press/monetary/20120620b.htm; table 1 is also available in
Part 4 of the July ``Monetary Policy Report to the Congress''.
\2\ Ben S. Bernanke (2012), ``Semiannual Monetary Policy Report to
the Congress'', statement before the Committee on Financial Services,
U.S. House of Representatives, February 29, www.federalreserve.gov/
newsevents/testimony/bernanke20120229a.htm.
---------------------------------------------------------------------------
The Committee made comparatively small changes in June to its
projections for inflation. Over the first 3 months of 2012, the price
index for personal consumption expenditures (PCE) rose about 3\1/2\
percent at an annual rate, boosted by a large increase in retail energy
prices that in turn reflected the higher cost of crude oil. However,
the sharp drop in crude oil prices in the past few months has brought
inflation down. In all, the PCE price index rose at an annual rate of
1\1/2\ percent over the first 5 months of this year, compared with a
2\1/2\ percent rise over 2011 as a whole. The central tendency of the
Committee's projections is that inflation will be 1.2 to 1.7 percent
this year, and at or below the 2 percent level that the Committee
judges to be consistent with its statutory mandate in 2013 and 2014.
Risks to the Outlook
Participants at the June FOMC meeting indicated that they see a
higher degree of uncertainty about their forecasts than normal and that
the risks to economic growth have increased. I would like to highlight
two main sources of risk: The first is the euro-area fiscal and banking
crisis; the second is the U.S. fiscal situation.
Earlier this year, financial strains in the euro area moderated in
response to a number of constructive steps by the European authorities,
including the provision of 3-year bank financing by the European
Central Bank. However, tensions in euro-area financial markets
intensified again more recently, reflecting political uncertainties in
Greece and news of losses at Spanish banks, which in turn raised
questions about Spain's fiscal position and the resilience of the euro-
area banking system more broadly. Euro-area authorities have responded
by announcing a number of measures, including funding for the
recapitalization of Spain's troubled banks, greater flexibility in the
use of the European financial backstops (including, potentially, the
flexibility to recapitalize banks directly rather than through loans to
sovereigns), and movement toward unified supervision of euro-area
banks. Even with these announcements, however, Europe's financial
markets and economy remain under significant stress, with spillover
effects on financial and economic conditions in the rest of the world,
including the United States. Moreover, the possibility that the
situation in Europe will worsen further remains a significant risk to
the outlook.
The Federal Reserve remains in close communication with our
European counterparts. Although the politics are complex, we believe
that the European authorities have both strong incentives and
sufficient resources to resolve the crisis. At the same time, we have
been focusing on improving the resilience of our financial system to
severe shocks, including those that might emanate from Europe. The
capital and liquidity positions of U.S. banking institutions have
improved substantially in recent years, and we have been working with
U.S. financial firms to ensure they are taking steps to manage the
risks associated with their exposures to Europe. That said, European
developments that resulted in a significant disruption in global
financial markets would inevitably pose significant challenges for our
financial system and our economy.
The second important risk to our recovery, as I mentioned, is the
domestic fiscal situation. As is well known, U.S. fiscal policies are
on an unsustainable path, and the development of a credible medium-term
plan for controlling deficits should be a high priority. At the same
time, fiscal decisions should take into account the fragility of the
recovery. That recovery could be endangered by the confluence of tax
increases and spending reductions that will take effect early next year
if no legislative action is taken. The Congressional Budget Office has
estimated that, if the full range of tax increases and spending cuts
were allowed to take effect--a scenario widely referred to as the
fiscal cliff--a shallow recession would occur early next year and about
1\1/4\ million fewer jobs would be created in 2013. \3\ These estimates
do not incorporate the additional negative effects likely to result
from public uncertainty about how these matters will be resolved. As
you recall, market volatility spiked and confidence fell last summer,
in part as a result of the protracted debate about the necessary
increase in the debt ceiling. Similar effects could ensue as the debt
ceiling and other difficult fiscal issues come into clearer view toward
the end of this year.
---------------------------------------------------------------------------
\3\ Congressional Budget Office (2012), ``Economic Effects of
Reducing the Fiscal Restraint That Is Scheduled To Occur in 2013''
(Washington: CBO, May), available at www.cbo.gov/publication/43262. The
effect of the fiscal cliff on real GDP is shown in table 2 (p.6). The
effect of the fiscal cliff on employment, relative to a less
restrictive alternative fiscal scenario that assumes that most expiring
tax provisions are extended and that the spending sequestration does
not take effect, is shown in table 3 (p.7).
---------------------------------------------------------------------------
The most effective way that the Congress could help to support the
economy right now would be to work to address the Nation's fiscal
challenges in a way that takes into account both the need for long-run
sustainability and the fragility of the recovery. Doing so earlier
rather than later would help reduce uncertainty and boost household and
business confidence.
Monetary Policy
In view of the weaker economic outlook, subdued projected path for
inflation, and significant downside risks to economic growth, the FOMC
decided to ease monetary policy at its June meeting by continuing its
maturity extension program (or MEP) through the end of this year. The
MEP combines sales of short-term Treasury securities with an equivalent
amount of purchases of longer-term Treasury securities. As a result, it
decreases the supply of longer-term Treasury securities available to
the public, putting upward pressure on the prices of those securities
and downward pressure on their yields, without affecting the overall
size of the Federal Reserve's balance sheet. By removing additional
longer-term Treasury securities from the market, the Fed's asset
purchases also induce private investors to acquire other longer-term
assets, such as corporate bonds and mortgage backed-securities, helping
to raise their prices and lower their yields and thereby making broader
financial conditions more accommodative.
Economic growth is also being supported by the exceptionally low
level of the target range for the Federal funds rate of 0 to \1/4\
percent and the Committee's forward guidance regarding the anticipated
path of the funds rate. As I reported in my February testimony, the
FOMC extended its forward guidance at its January meeting, noting that
it expects that economic conditions--including low rates of resource
utilization and a subdued outlook for inflation over the medium run--
are likely to warrant exceptionally low levels for the Federal funds
rate at least through late 2014. The Committee has maintained this
conditional forward guidance at its subsequent meetings. Reflecting its
concerns about the slow pace of progress in reducing unemployment and
the downside risks to the economic outlook, the Committee made clear at
its June meeting that it is prepared to take further action as
appropriate to promote a stronger economic recovery and sustained
improvement in labor market conditions in a context of price stability.
Thank you. I would be pleased to take your questions.
RESPONSES TO WRITTEN QUESTIONS OF
CHAIRMAN JOHNSON FROM BEN S. BERNANKE
Q.1. At the hearing you mentioned potential alternatives to
LIBOR. What next steps should be taken to either reform or
replace LIBOR as a benchmark for the interest rates on
financial products? What should the Fed's role be in any
international process to reform or replace it?
A.1. Answer not received by time of publication.
Q.2. Critics of Wall Street Reform claim that the law is
holding back the economic recovery. What has had a greater
impact on high unemployment today--the Wall Street Reform Act
or the ineffective regulations that led to the financial
crisis? Can you offer examples of how the financial system is
now safer as a result of policies that the Fed has implemented
pursuant to the Wall Street Reform Act?
A.2. The recent financial crisis demonstrated that some
financial companies had grown so large, leveraged, and
interconnected, that their failure could pose a threat to
overall financial stability. The crisis also exposed
significant weaknesses in banking organizations' internal
management and stress testing practices, as well as
deficiencies in the regulators' toolkit to address them. In
addition, the amount of high-quality capital held by banking
organizations globally was insufficient to absorb losses that
banking organizations experienced during that period.
Insufficient liquidity and associated risk management practices
also directly contributed to the failure or near failure of
many companies and exacerbated the crisis. To address these and
other weaknesses, the Federal Reserve has taken various steps
to improve the regulation and supervision of individual firms
to enhance their resiliency in times of stress, as well as the
resiliency of the financial system as a whole. These measures
have been taken pursuant to the Dodd-Frank Wall Street Reform
and Consumer Protection Act (Dodd-Frank Act), as well as the
Federal Reserve's authority as the supervisor of various
financial institutions.
For example, in January 2012, the Board published for
comment proposed rules that would implement the enhanced
prudential standards and early remediation requirements of
sections 165 and 166 of the Dodd-Frank Act. The proposal
generally applies to all U.S. bank holding companies with total
consolidated assets of $50 billion or more and nonbank
financial companies that the Financial Stability Oversight
Council has designated for supervision by the Board (covered
companies). The proposal addresses issues such as capital,
liquidity, single counterparty credit limits, stress testing,
risk management, and early remediation requirements. The Board
intends to supplement the enhanced risk-based capital and
leverage requirements proposed in January 2012 with a
subsequent proposal to implement a quantitative risk-based
capital surcharge for covered companies or a subset of covered
companies. To further implement the provisions of sections 165
and 166 of the Dodd-Frank Act, the Board issued proposed rules
in December 2012 to strengthen the oversight of the U.S.
operations of large foreign banking organizations, including
measures regarding early remediation, capital stress testing,
overall risk management, and enhanced risk-based and leverage
requirements for these organizations. These proposals are aimed
at strengthening the regulatory framework to address the risks
that large, interconnected financial institutions pose to U.S.
financial stability.
In addition, in June 2012, the Board and the other Federal
banking agencies issued three notices of proposed rulemaking
that would effectively result in increasing the quantity and
quality of capital held by banking organizations. The proposed
rules would introduce a new common equity tier 1 capital
requirement, raise existing minimum tier 1 capital
requirements, and implement a capital conservation buffer to
increase the resiliency of all banking organizations during
times of economic and financial stress. The proposed rules
would also be incorporated into the enhanced standards for
covered companies discussed above. These measures are designed
to help address the shortcomings in the international capital
standards exposed during the crisis and build additional
capacity into the banking system to absorb losses in times of
future market and economic stress. The proposals also would
enhance the risk-sensitivity of the agencies' capital
requirements by revising the calculation of risk-weighted
assets for certain exposures to address weaknesses identified
in the capital framework in recent years.
The Federal Reserve has also been working to embed its
supervisory practices within a broader macroprudential
framework that focuses not only on the conditions of individual
firms but also on the health of the financial system as a
whole. Even before the enactment of the Dodd-Frank Act, the
Federal Reserve had begun to overhaul its approach to
supervision to better achieve both microprudential and
macroprudential goals. For example, in 2009, the Federal
Reserve created the Large Institution Supervision Coordinating
Committee, which oversees the supervision of the most
systemically important financial firms. Another important
example of the Federal Reserve's strengthened, cross-firm
supervisory approach is the Comprehensive Capital Analysis and
Review, through which the Federal Reserve assesses the internal
capital planning processes of the largest bank holding
companies and evaluates their capital adequacy under a very
severe hypothetical stress scenario. Largely as a result of
these efforts and the Federal Reserve's action during the
crisis, the aggregate amount of tier 1 common for the 19
largest bank holding companies increased by more than $300
billion between 2009 and 2012. The Federal Reserve also
routinely uses macroprudential tools in analyzing the potential
consequences of significant economic events for the individual
firms it supervises and for the financial system as a whole.
The proposed enhanced prudential standards and regulatory
capital requirements, as well as other additional steps that
the Federal Reserve has taken in response to the crisis and
pursuant to the Dodd-Frank Act, are designed to strengthen the
banking system and the financial system as a whole by
strengthening regulatory requirements and the supervision of
the most systemically important financial firms.
Q.3. Do you think that the policy changes announced at the
recent EU summit go far enough toward solving the European
financial crisis? How will U.S. banks be affected by the
proposed eurozone banking union?
A.3. At their late June summit, European leaders agreed on a
number of measures to address the financial crisis. These
included, among other steps, establishing a single supervisory
mechanism for European banks and, once such a mechanism is in
place, enabling the European Stability Mechanism (ESM), the
permanent euro-area backstop facility, to recapitalize banks
directly. Subsequently, European leaders have also made
progress in enhancing regional policy support for vulnerable
euro-area countries. The European Central Bank (ECB) has
announced a program that would enable it to purchase sovereign
debt in order to address market distortions and contain bond
yields. Countries benefiting from ECB support will have to
enter into assistance programs and commit to achieving
appropriate conditions prior to ECB assistance.
These developments have helped ease stresses in European
financial markets and hold out the hope of further progress
toward resolution of the crisis. However, European leaders must
follow through on their commitments by agreeing to specific,
detailed plans and then implementing them. Market participants
have reacted favorably to announcements of the ECB's new bond
purchase framework, but more work must be done to
operationalize this strategy. By the same token, further
agreements among European authorities will be required before
the single supervisory mechanism for banks can be put in place.
Additionally, if a full resolution of Europe's difficulties is
to be achieved, these regional initiatives must be complemented
by further actions in the vulnerable countries themselves to
improve public finances, strengthen banking systems, and
promote pro-growth structural reforms.
Euro-area banks currently are supervised by 17 national
supervisors. Establishing a single supervisory mechanism should
help to streamline supervisory compliance costs, further the
integration of the European financial market and make it easier
for international banks, including U.S. banks, to conduct
business within and across euro-area countries. Moreover,
tougher and more consistent bank supervision in Europe should
reduce the frequency and severity of financial distress of
European banks and hence contribute to global financial
stability.
Q.4. What are the barriers preventing homeowners who are
current on their mortgage payments from refinancing? Could
legislation address those barriers, and how would such
legislation help with economic recovery?
A.4. Low credit scores or levels of home equity make it
difficult for many borrowers to refinance their mortgages.
Initiatives such as the Home Affordable Refinance Program
(HARP) and the streamlined refinance program offered by the
Federal Housing Administration (FHA) have reduced or eliminated
these barriers for many borrowers with loans guaranteed or
insured by Fannie Mae, Freddie Mac, or FHA. However, borrowers
whose loans are held in bank portfolios or private-label
mortgage-backed securities, as well as borrowers who have
already refinanced through HARP, often face significant
obstacles to refinancing if their credit scores or home equity
fall below certain levels. The Monetary Policy Report submitted
to the Congress on July 17, 2012, and the staff housing paper
sent to the Committee on Banking, Housing, and Urban Affairs on
January 4, 2012, provide further discussion of these issues.
The Congress could facilitate refinancing for these
borrowers by legislating changes to HARP or the FHA refinancing
program or by creating a new refinancing program. In designing
such legislation, the Congress would have to consider how to
balance the interests of borrowers, taxpayers, and investors. A
refinancing program might provide a small boost to aggregate
consumer spending, decrease the incidence of mortgage default,
and improve consumer confidence, but the size of such effects
is difficult to predict.
Q.5. The Fed is proposing a set of rules implementing Sections
165 and 171 of the Wall Street Reform Act and the Basel III
agreements. These rules would apply to insurance companies
organized as thrift holding companies or designated as nonbank
financial SIFIs. Did the Fed consult with the Federal Insurance
Office (FIO)? Do you anticipate that you will consult regularly
with FIO as you engage in rulemakings that impact insurance
companies? What else is the Fed doing to develop its insurance
expertise? As part of these rulemakings, what steps did the Fed
take to analyze the differences between banks and insurance
companies and to incorporate those findings into the
rulemakings? Do you think that the recent actions and
rulemakings of the Fed appropriately recognize the differences
between insurance companies and banks?
A.5. Board staff has consulted with the Federal Insurance
Office on issues related to capital requirements, stress
testing, and insurance matters generally. Board staff also met
with industry representatives and with the National Association
of Insurance Commissioners on several occasions to discuss
insurance-related issues. The Board also sought public comment
on capital and accounting issues as well as on regulatory and
supervisory requirements for savings and loan holding companies
when it published a notice of intent regarding these
institutions on April 22, 2011. The Board expects to continue
this practice of consultations with other regulators and
standard-setters, as well as the industry and the public, to
further the Board's expertise and to gain additional
perspectives on the regulation and supervision of insurance
companies as appropriate.
In June 2012, the Board and the other Federal banking
agencies proposed to revise risk-based and leverage capital
requirements in three notices of proposed rulemaking. In
proposing the regulatory capital requirements, the Board sought
to meet several legal requirements and policy goals. Section
171 of the Dodd-Frank Act, requires that the Board establish
minimum consolidated risk-based and leverage capital
requirements for savings and loan holding companies that are
not less than the ``generally applicable'' risk-based and
leverage capital requirements for insured depository
institutions. Accordingly, the proposals include consistent
treatment for similar types of exposures, whether held at a
depository institution or a savings and loan holding company,
as well as provide flexibility for certain insurance-related
assets that generally are not held by depository institutions.
For example, the proposals include specific risk-weights for
policy loans and nonguaranteed separate accounts, which are
typically held by insurance companies but not depository
institutions.
The Board has received numerous comments from the public on
the proposals with regard to the application of the proposed
rules to insurance-centric savings and loan holding companies.
The Board will carefully consider all the comments received
while finalizing the regulatory capital rules.
Q.6. The recent losses at JPMorgan have renewed focus on risk
management practices. Additionally, JPMorgan has stated that
the firm changed its risk models and trading positions in
anticipation of new capital requirements under Basel III.
Please provide your comments on how new capital requirements
will strengthen the financial system, as well as any potential
risks that may arise from these new capital standards. If the
new standards encourage institutions to shift their activities
into other risky activities, or have other unintended
consequences, please comment on how you plan to address those
shifts. In your answer, please also include any expectations
you may have regarding institutional risk management and the
Fed's supervision of risk management at institutions.
A.6. In June 2012, in addition to issuing the proposed rules
described in the answer to Question 2 above, the Federal
banking agencies approved a final rule to implement changes to
the market risk capital rule that applies to banking
organizations with significant trading activity. \1\ The
changes are primarily designed to ensure appropriate capital is
held against trading positions, reduce the procyclicality of
the capital requirements, and enhance the measure of credit
risk of traded positions. Thus, the rule is expected to help
ensure that banking organizations maintain stronger capital
positions and improve the resilience of the U.S. banking system
in times of stress, thus contributing to the overall health of
the U.S. economy.
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\1\ 77 FR 53060.
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There are risks that banking organizations may alter their
practices and engage in different activities as a result of new
and proposed capital rules. However, the Federal Reserve has a
comprehensive supervisory framework and regulations beyond the
regulatory capital rules to help address these risks. For
example, a supervisory assessment of banking organizations'
capital adequacy takes into account a banking organization's
internal processes for capital adequacy, as well as risks and
other factors that can affect the banking organization's
financial condition, including the level and severity of
problem assets and the organization's exposure to operational
and interest rate risk. \2\ For internationally active
institutions, the supervisory review process for capital
adequacy (the so-called Pillar 2 approach based on the
international Basel II standards) is even more rigorous and
comprehensive as it emphasizes the need for these institutions
to look beyond the regulatory capital standards and to help
institution's ensure that they maintain adequate capital levels
in relation to their risk profiles. Further, for the largest
U.S. bank holding companies, the Federal Reserve has
established regulatory requirements for regular stress testing
and capital planning and conducts supervisory assessments of
the capital planning processes and capital adequacy of these
firms.
---------------------------------------------------------------------------
\2\ See, for example, SR 09-04, ``Applying Supervisory Guidance
and Regulations on the Payment of Dividends, Stock Redemptions, and
Stock Repurchases at Bank Holding Companies''; see also June 2012
proposed regulatory capital rule, 77 FR 52792).
---------------------------------------------------------------------------
The Federal Reserve has also put forth other guidance for
banking organizations related to risk management in Supervision
and Regulation Letters. For example, the Federal banking
agencies finalized stress testing guidance in May 2012 for
banking organizations with total consolidated assets of more
than $10 billion that focuses on the importance of banking
organizations conducting forward-looking assessments of their
risks to better equip them to address a range of adverse
outcomes. The supervisory guidance on model risk management,
issued in April 2011, describes key aspects of the effective
model risk management, as well as key principles of sound
governance and internal controls governing the use of models.
These and other supervisory guidance and regulations are
designed to improve banking organizations' risk management
practices, as well as the supervisory toolkit to enforce robust
procedures and sound risk management so that banking
organizations manage their risks effectively and hold adequate
capital commensurate with their risk profiles.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR REED
FROM BEN S. BERNANKE
Q.1. It is my understanding that the Federal Reserve supervises
Citigroup, JPMorgan Chase, Bank of America Corp, and the U.S.
branches of foreign banks. As these institutions face
potentially billions of dollars in fines, legal costs, and
settlements due to their involvement in the LIBOR setting
process, why did the Federal Reserve not consider this to be a
safety and soundness concern?
A.1. Answer not received by time of publication.
Q.2. How does the Federal Reserve define an unsafe or unsound
practice? What authority does the Federal Reserve have to end
an unsafe and unsound practice in institutions it supervises?
A.2. Answer not received by time of publication.
Q.3. Do you have ``cease and desist'' authority which could,
for example, be used to stop traders and employees responsible
for determining LIBOR submissions at supervised institutions
from manipulating and falsely reporting LIBOR? If so, why did
the Federal Reserve decide not to use it?
A.3. Answer not received by time of publication.
Q.4. Does the Federal Reserve have authority to require
supervised institutions to adopt better internal controls to
prevent traders and others from making unlawful requests to
employees responsible for determining LIBOR? If so, why did you
decide not to use this authority?
A.4. Answer not received by time of publication.
Q.5. Did analysts with the New York Federal Markets Group
analysts engage with Federal Reserve supervisory staff
overseeing Citigroup, JPMorgan Chase, or Bank of America
regarding potential issues with the accuracy of LIBOR
reporting? If so, on what dates did these interactions happen
and what was the general substance of those conversations. If
not, why not?
A.5. Answer not received by time of publication.
Q.6. Were the April 2008 briefing notes and the May 20, 2008,
report prepared by the Federal Markets Group regarding the
accuracy of LIBOR reporting circulated to the staff responsible
for supervising these institutions at the New York Fed or the
Federal Reserve? Why or why not?
A.6. Answer not received by time of publication.
Q.7. Were appropriate internal controls in place at the Federal
Reserve to make sure that appropriate and timely actions were
taken regarding potential LIBOR fraud? Are you reviewing the
conduct and behavior of your analysts and supervisory staff
with responsibility for overseeing institutions involved in the
LIBOR setting process? If not, why not? If so, what changes and
remedial actions have you taken?
A.7. Answer not received by time of publication.
Q.8. Regardless of the fact that direct supervision for the
setting of LIBOR was under the purview of U.K. regulators, the
Federal Reserve had supervisory responsibility for three of the
institutions involved in setting the rate. Was it the policy of
the Federal Reserve to defer to foreign regulators even though
there was evidence that institutions supervised by the Fed were
involved in potential manipulation of LIBOR?
A.8. Answer not received by time of publication.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR WARNER
FROM BEN S. BERNANKE
Q.1. The Bank Supervision Groups of the 12 Federal Reserve
Banks include approximately 3,600 staff, and they are scattered
across the country. The banking and financial industries,
however, are concentrated in New York where 7 of the 10 largest
bank holding companies are located. Why are the examination
resources of the Federal Reserve System still split up evenly
over the 12 regional banks? Should the resources be dispersed
in a more proportional manner to the location and size of
regulated entities?
A.1. The Federal Reserve supervises state-chartered banks that
have chosen to become members of the Federal Reserve System
(state member banks); bank holding companies and savings and
loan holding companies and any nonbanking subsidiary of such
companies that is not functionally regulated by another federal
or state regulator; foreign branches of member banks; Edge Act
and agreement corporations; U.S. State-licensed branches,
agencies, and representative offices of foreign banks; and the
U.S. nonbanking activities of foreign banks. Supervisory
resources and expertise are dispersed across the Federal
Reserve System as needed to effectively supervise these
institutions based on their number, size, complexity, and
activities. The Federal Reserve Bank of New York has the
largest number of supervision staff. More than half of all the
Reserve Bank supervision staff is located in the New York,
Chicago, Richmond, and Atlanta districts. Where cost and
supervisory efficiencies can be gained by consolidating or
sharing expertise, the Federal Reserve has developed a program
for sharing subject matter experts and other staff among the
Reserve Banks.
Q.2. In 2005, a peer group of other Federal Reserve Banks found
that the supervision team at the New York Fed appeared to have
``insufficient resources to conduct continuous supervisory
activities in a consistent manner'' for certain institutions.
In 2009, another peer group study concluded that ``there have
been significant weaknesses in the execution of the supervisory
program'' at the New York Fed. When the Financial Crisis
Inquiry Commission (FCIC) made these criticisms public, the New
York Fed responded by increasing the resources applied.
Can you give additional detail on how examiners and other
supervisory resources have been increased or reallocated since
2005? How many examiners out of 3,600 supervision staff are
embedded at each of the 10 largest banks? Are published reports
accurate that say about 200 examiners total are embedded at the
5 largest Wall Street banks?
A.2. Since 2005, and especially since the financial crisis, the
Federal Reserve has sharpened its supervisory focus by
increasing its depth of understanding of the supervised
organizations and key vulnerabilities and by enhancing the
level and size of the embedded onsite teams at the largest
institutions. The published reports on the number of examiners
cited in the question are generally correct. Resources
allocated to the largest organizations have increased and are
currently numbered at approximately 230. In addition, a wide
range of subject matter experts support the on-site embedded
teams. The Federal Reserve's consolidated supervision framework
for large financial institutions is described in greater detail
in Supervision and Regulation Letter 12-17 issued on December
17, 2012 (http://www.federalreserve.gov/bankinforeg/srletters/
sr1217.htm).
It is also important to note that, by law, the Federal
Reserve must rely to the fullest extent possible on
examinations conducted by the OCC, the FDIC, and the SEC. Each
of these agencies deploys substantial resources in the
examination and supervision of large subsidiaries owned by the
largest bank holding companies.
Q.3. When the term ``unsafe or sound practice'' was added to
Federal law to authorize cease and desist orders, the following
was stated to be the working definition of an unsafe or sound
practice.
Generally speaking, an ``unsafe or unsound practice''
embraces any action, or lack of action, which is contrary to
generally accepted standards of prudent operation, the possible
consequences of which, if continued, would be abnormal risk or
loss or damage to an institution, its shareholders, or the
agencies administering the insurance fund. Financial
Institutions Supervisory Act of 1966: Hearings on S.3158 Before
the House Committee on Banking and Currency, 89th Cong., 2d
Sess. at 49-50 (1966) (statement of Chairman Horne).
Given the litigation and other penalties that Barclays and
additional banks are confronting, do you believe that the
allegedly purposeful false LIBOR reports British Banking
Association raise a ``safety and soundness'' concern?
A.3. Answer not received by time of publication.
Q.4. In 2008, the New York Federal Reserve Bank had evidence
that Barclays was intentionally manipulating LIBOR, and as you
said in your testimony, there were numerous reports in the
financial press about other apparent misbehavior with respect
to LIBOR. The examination and supervision model used by the
Federal Reserve relies extensively on the internal risk
management reports and internal audit reports of the banking
organizations it exams and supervises.
Since 2008, has the New York Federal Reserve Bank, or any
other Federal Reserve Bank, ever conducted an examination of
the internal controls of any banking organization with respect
to its provision of LIBOR indications? Could examinations of
internal controls have prevented inaccurate reports from
Barclays and other LIBOR reporters during the last 5 years?
A.4. Answer not received by time of publication.
Q.5. I have heard concerns from constituent savings and loan
holding companies regarding the length of the comment period
and the burden of the accounting changes required by the
``Advanced Approaches Risk-based Capital Rule; Market Risk
Capital Rule'' released on June 7th. Can you discuss the
expected costs and additional impacts to insurers that own
savings and loan banks based on the accounting change to GAAP?
Was the Federal Office of Insurance consulted with during the
drafting process?
A.5.As you know, the Board and the other Federal banking
agencies proposed to revise the risk-based and leverage capital
requirements in three notices of proposed rulemaking (NPRs) and
the Board proposed to apply the revised requirements to SLHCs.
\1\ The proposals in the NPRs, in part, would apply
consolidated risk-based capital requirements to a depository
institution holding company and its subsidiaries. Currently,
capital requirements for insurance companies are imposed by
State insurance laws on a legal entity basis and there are no
State-based, consolidated capital requirements that cover
subsidiaries and noninsurance affiliates of insurance
companies.
---------------------------------------------------------------------------
\1\ See, 77 Federal Register 52888, 52909, 52958 (August 30,
2012).
---------------------------------------------------------------------------
In developing the NPRs, the Board sought to meet several
legal requirements and policy goals. The NPRs are consistent
with section 171 of the Dodd-Frank Act, which requires
consolidated minimum risk-based and leverage capital
requirements for depository institution holding companies,
including SLHCs, that are no less than the generally applicable
capital requirements that apply to insured depository
institutions under the prompt corrective action framework. The
current ``generally applicable'' capital requirements for
insured depository institutions are calculated and reported
based on the U.S. generally accepted accounting principles
(GAAP). This approach is consistent with section 37 of the
Federal Deposit Insurance Act which requires that accounting
principles applicable to reports or statements that insured
depository institutions file with their Federal regulators be
``uniform and consistent'' with GAAP. If an alternative
accounting standard is required by the Federal regulator, it
must, by statute, be ``no less stringent'' than GAAP. \2\
Accordingly, the Board, consistent with section 171 of Dodd-
Frank Act and section 37 of the FDI Act, proposed that savings
and loan holding companies, like insured depository
institutions and bank holding companies, calculate and report
their regulatory capital ratios on a consolidated basis using a
framework that is based on GAAP.
---------------------------------------------------------------------------
\2\ See, 12 U.S.C. 1831n(a)(2).
---------------------------------------------------------------------------
The NPRs also are consistent with the Board's long-standing
practice of applying consolidated minimum capital requirements
to bank holding companies, including those that control
functionally regulated subsidiary insurance companies. This
practice eliminates incentives to engage in capital arbitrage
by booking individual exposures in the legal entity in which
they receive the most favorable capital requirement.
In developing the proposals, Board staff consulted with the
Federal Insurance Office on issues related to capital
requirements and stress testing. The Board also sought public
comment on capital-related and accounting-related issues that
may affect savings and loan holding companies when the Board
published a notice of intent regarding these companies on April
22, 2011. Board staff also has met with a number of industry
representatives to discuss challenges associated with applying
consolidated capital requirements to savings and loan holding
companies, including those challenges related to using GAAP.
The Board has received numerous public comments on the
potential cost and implementation challenges for savings and
loan holding companies, including those savings and loan
holding companies that do not currently use GAAP. Board staff
and Board members have also met with representatives of savings
and loan holding companies with large insurance operations
about the concerns raised in their comment letters. The Board
is carefully reviewing all the public comments on the proposal,
including those related to potential costs and burdens related
to accounting, and will continue to take these concerns into
consideration over the course of the rulemaking.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR MERKLEY
FROM BEN S. BERNANKE
Q.1. During the hearing, I asked you to address concerns I have
regarding the increasing role that banks are playing in our
spot energy markets, including the crude oil markets. I
particularly asked this in light of the regulators' October
proposal on the Volcker Rule that would exclude all spot
commodities and physically settled forwards from coverage of
the Volcker Rule's trading account. You responded by suggesting
that Dodd-Frank had excluded spot commodities from Volcker Rule
coverage, and I indicated that this was not the case.
I would like take you up on your offer of further
conversation and analysis of the issue. First, let me share
some of my views on this matter, and I would like to understand
your views in light of them.
Although Dodd-Frank does not explicitly name spot
commodities and physically settled commodity forwards in the
trading account definition under the statutory Volcker Rule,
that definition is exceedingly broad and expresses a clear
Congressional intent to cover all instruments banks use in the
course of their trading activities. Moreover, Dodd-Frank
provides regulators broad authority to include ``any other
security or financial instrument.'' In other words, the text of
the statute might not explicitly include the items in question,
but it does not take that ability away from the regulators.
Indeed, any explicit decision to exclude them would be made by
the regulators, and I would assert would be a misreading of
Congressional intent.
For your reference, below is the pertinent statutory text:
(4) PROPRIETARY TRADING.--The term ``proprietary
trading'', when used with respect to a banking entity
or nonbank financial company supervised by the Board,
means engaging as a principal for the trading account
of the banking entity or nonbank financial company
supervised by the Board in any transaction to purchase
or sell, or otherwise acquire or dispose of, any
security, any derivative, any contract of sale of a
commodity for future delivery, any option on any such
security, derivative, or contract, or any other
security or financial instrument that the appropriate
Federal banking agencies, the Securities and Exchange
Commission, and the Commodity Futures Trading
Commission may, by rule as provided in subsection
(b)(2), determine.
Senator Levin and I further make this clear in our February
13 comment letter on this subject:
The law provides no statutory authority to exclude
transactions involving spot commodities or forward
contract transactions that are to be physically settled
from the Merkley-Levin Provisions, nor should they be
excluded. Until relatively recently, banks and their
affiliates were not major players in physical
commodities. Today, some banks have become major
traders of physical commodities, using transactions
which can be high risk, give rise to off balance sheet
or other hidden liabilities, and involve difficult risk
analysis. For example, some banks such as JPMorgan and
Morgan Stanley are reportedly trading and storing
physical quantities of crude oil and other physical
commodities, \1\ and engaging in trading activities and
investments that regulators may be hard pressed to
analyze for risk or conflicts of interest.
---------------------------------------------------------------------------
\1\ See, e.g., Ned Molloy, ``Energy Risk Oil & Products House of
the Year 2011: JPMorgan'', Risk.net, Jun. 9, 2011, available at http://
www.risk.net/energy-risk/feature/2072271/energy-risk-oil-products-
house-2011-jp-morgan; Morning Zhou, ``Traders Boost Oil Storage on
Offshore Tankers by 75%, Morgan Stanley Says'', Bloomberg, Apr. 26,
2010, available at http://www.bloomberg.com/news/2010-04-26/traders-
boost-oil-storage-on-offshore-tankers-by-75-morgan-stanley-says.html;
Wall Street Banks Quarterly Commodities Trading Risk, Reuters, Oct. 18,
2011, available at http://www.reuters.com/article/2011/10/18/
commodities-banks-risk-idUSN1 E79H0M920111018.
In addition, these transactions invite the very types
of conflicts of interest that the Merkley-Levin
Provisions are designed to prevent, since those same
banks frequently engage in commodity transactions with
and on behalf of their clients. \2\ Although these
types of transactions are not explicitly named in the
statute, they are covered under the ``any other
security or financial instrument'' language of Section
13(h)(4). In addition, excluding these types of
transactions from the statute would create incentives
for banks to circumvent the law by designing
transactions utilizing these exclusions. In addition,
given the strong relationships between spot commodities
and their corresponding futures, excluding spot
commodities would create a significant loophole that
would undermine the intent of the provisions. Given the
risk of evasion, all of these transactions should be
subject to the Volcker Rule safeguards.
---------------------------------------------------------------------------
\2\ See, Saule Omarova, 63 U. Miami L. Rev. 1041 (2009).
Not only do I believe the statutory approach is clear, but
the policy basis for being concerned about banks' spot
commodities and physically settled forwards trading is very
strong. Recent events, including the JPMorgan Chief trading
loss, the trader manipulation of LIBOR cases, and the on-going
investigation by the Federal Energy Regulatory Commission into
energy manipulation by several large national banks, all
highlight how the culture of proprietary trading is so rife
with conflicts of interest and risk that it is highly
incompatible with client-oriented, economy-serving traditional
banking. Indeed, many trading activities may even be so risky
as to be beyond cost-effective regulation--a point suggested by
Federal Reserve Governor Sarah Bloom Raskin in a recent speech
in Colorado.
Given these lessons, I am highly concerned the regulators
would seek to ignore the statute and pass up the opportunity to
use the Volcker Rule to hopefully prevent potential problems in
our energy and other commodity markets, including possibly
preventing another Enron.
Please share any additional views you may have in light of
this information.
A.1. 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. As you
noted, section 619(h)(4) of that Act defines ``proprietary
trading'' to mean ``engaging as a principal for the trading
account of the banking entity or nonbank financial company
supervised by the Board in any transaction to purchase or sell,
or otherwise acquire or dispose of, any security, any
derivative, any contract of sale of a commodity for future
delivery, any option on any such security, derivative, or
contract, or any other security or financial instrument that
the appropriate Federal banking agencies, the Securities and
Exchange Commission, and the Commodity Futures Trading
Commission may, by rule as provided in subsection (b)(2),
determine.'' See 12 U.S.C. 1851(h)(4). By its terms, section
619(h)(4) does not mention or specifically apply to spot
transactions in commodities.
As you point out, the Act permits the Federal Reserve, OCC,
FDIC, SEC, and CFTC (the ``Agencies'') to extend the
prohibition on proprietary trading to ``any other security or
financial instrument that the [Agencies] may, by rule as
provided in subsection (b)(2) [of section 619], determine.''
See, id., The Agencies invited comment on the appropriate scope
of this definition, including whether the Agencies should
extend the definition to include spot commodities. The Agencies
received over 19,000 comments regarding the proposed
implementing rules, including, as noted in our discussion,
comments that specifically addressed the definition of covered
financial position and the scope of instruments that should be
subject to the ban on proprietary trading. The Agencies are
currently considering these comments as we work to finalize
implementing rules, and will carefully consider your comments
in implementing these important provisions.
Q.2. Similar to the concern I have with the exclusion of spot
commodities and forwards from the definition of the trading
account is the proposal to exclude repurchase agreements and
``liquidity management'' positions from the trading account--
and hence the entire coverage of the Volcker Rule.
As I indicated in Question 1, the statute does not provide
a path for excluding items from, the definition of the trading
account. It provides only one avenue for avoiding from the
prohibitions of the Volcker Rule: an additional ``permitted
activity'' under subsection (d)(1)(J) of the statute. This path
was expressly provided so that regulators could, if needed, add
permitted activities. Although these activities would not be
subject to the prohibition on proprietary trading, they would
remain subject to other protections under the Volcker Rule,
including data collection and backstops on high-risk activities
and conflicts of interest.
Senator Levin and I, in our February comment letter, made
this point clearly:
The Merkley-Levin Provisions do not provide any
statutory authority to create exclusions from the
definition of ``trading account''. To the contrary, it
authorizes the regulators only to expand the definition
of ``trading account'' to include ``any such other
accounts'' as they determine. Thus, regulatory
discretion is only in one direction.
Positions held outside of the ``trading account'', as
defined by the statute and [ ] should [they] be
expanded by the regulators, are not directly covered by
the restrictions in the Merkley-Levin Provisions
against proprietary trading, much less their
protections against high-risk assets, conflicts of
interest, and other protections.
The definition of ``trading account'' was carefully
worded in the statute to take into account multiple
concerns and deliberately designed to have a broad
reach. The statute does not contemplate or provide for
exclusions from this definition. If regulators want to
allow a new permitted activity, then they must do so
pursuant to the authority under Section 13(d)(1)(J),
which would ensure that the new activity remained
subject to the other limitations in the law applicable
to all permitted activities. In short, there is no
legal standing for these regulatory-created exclusions
from the definition of ``trading account,'' and they
should be removed.
Given that many of JPMorgan's Chief Investment Office
positions were held, they claimed, as liquidity management
positions, complete exclusion of liquidity management positions
from the Volcker Rule would not only be contrary to the
statutory text but also highly troubling from a policy
perspective.
Please comment on whether you intend to close the liquidity
management and other exclusions from the Volcker Rule trading
account definition.
A.2. The proposal by the Agencies to implement section 619 of
the Dodd-Frank Act requested public comment on a definition of
``trading account'' that generally restates the statutory
definition, with the addition of certain details to provide
greater clarity regarding the scope of positions that fall
within the definition. That definition covers trading activity
conducted principally for the purpose of selling in the near
term or profiting from short-term price movements. The Agencies
proposed to clarify that transactions taken as part of bona
fide liquidity management activities, repurchase or reverse
repurchase arrangements, or securities lending programs are not
covered within the trading account because the banking entity's
purpose for engaging in such transactions is not to engage in
selling in the near term or profiting from short-term price
movements. For instance, banking entities conduct liquidity
management activities as part of a program reviewed by the
Agencies to ensure that each banking entity maintains
sufficient, readily marketable assets to meet its expected
short-term liquidity needs, and thereby enhance the safe and
sound operation of the banking entity and reduce its risk to
the financial system. Similarly, repurchase or reverse
repurchase arrangements and securities lending transactions
operate in substance as a secured loan with set terms agreed
upon at the start of the arrangement, and are not based on
expected or anticipated short-term movements in asset prices.
The Agencies invited comment on the proposed exclusions and
the Agencies received over 19,000 comments regarding the
proposed implementing rules, including comments that
specifically addressed the issues you noted in your question.
The Federal Reserve and other rulemaking agencies are carefully
reviewing those comments and considering the suggestions and
issues they raise in light of the statutory restrictions and
provisions as we work to finalize implementing rules.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
FROM BEN S. BERNANKE
Q.1. I am concerned about the April 10th supplemental notice of
proposed rulemaking issued by the Fed. In this NPR, the Fed
ignores the letter of the law in Dodd Frank, and proposes to
vastly expand its own authority to designate nonfinancial firms
as SIFIs ``predominantly engaged in financial services'' by
adopting a broad definition of the term ``activities that are
financial in nature.''
During the Senate's consideration of the Dodd-Frank Act a
bipartisan amendment that significantly tightened the bill's
language regarding SIFI designation for nonbanks. My concern
was that the committee-reported bill gave the Fed and the FSOC
broad discretion to adopt a drag-net approach to SIFI
designation--and in doing so, pull in many commercial firms
that Congress did not want included.
The Vitter-Pryor amendment cured this defect by limiting
the designation process to only those firms that are
``predominantly engaged'' in financial services. This amendment
created a new standard for SIFI designation. Under it, a firm
must be predominantly engaged in activities that are financial
in nature to be subject to FSOC designation. It also linked the
``predominantly engaged'' definition to the tight definition of
``financial activities'' in the Bank Holding Company Act. The
language is crystal clear--``activities that are financial in
nature as defined in section 4(k) of the Bank Holding Company
Act of 1956'' qualify as ``financial in nature.'' The Senate
rejected adding a clause to this amendment granting the Board
the additional discretion to consider activities ``incidental
to a financial activity'' as defined in section 4(k).
Nevertheless, the Fed in its April 10th NPR, has decided to
ignore the clear letter of the law and unilaterally expand the
definition of this term.
In that NPR the Fed rationalizes its action as necessary to
not ``severely undermine the purposes of Title I.'' This is not
the Fed's decision to make. Given the explicit language of the
statute, the Fed is not empowered to try to divine the
``purposes'' of Title I by sifting through the legislative
history of Dodd-Frank. The language of Section 102 and the
legislative history of this provision make it abundantly clear
that the language of Section 4(k) controls, and the Fed has no
discretion to bend the law. Moreover, the debate surrounding
our Amendment make clear that the Congress intended this
language to mean exactly what it says.
The Supreme Court has repeatedly upheld the proposition
that agencies must defer to clear Congressional intent. In K
Mart v. Cartier, Inc., the Court wrote that ``if a statute is
clear and unambiguous that is the end of the matter . . . the
agency must give effect to the unambiguously expressed intent
of Congress.'' Given the precedents, what basis does the
Federal Reserve have for its attempt to qualify the clear
language of Section 102(a)(6)?
A.1. Questions 1 through 3 relate to the provision of the Dodd-
Frank Act that requires the Board to establish, by regulation,
the requirements for determining if a company is predominantly
engaged in financial activities. Companies that are
predominantly engaged in financial activities can be designated
by the Financial Stability Oversight Council for supervision by
the Board if the FSOC finds that the firm could pose a threat
to the financial stability of the United States.
In April 2012, the Board invited public comment on proposed
rules implementing these provisions. The public provided a
number of comments on the proposed rules, including with
respect to the proposed interpretation of section 102 of the
Dodd-Frank Act and the treatment of physically settled
derivatives transactions. We are carefully considering these
comments as we formulate the final rule.
Q.2. Chairman Bernanke, in the April 10th release, the Federal
Reserve attempts to justify its proposed action by citing
section 102(b) of the Dodd Frank Act. That provision permits
the Fed to establish ``requirements'' for determining whether a
company falls within the definition of ``predominantly engaged
in financial activities''. This provision explicitly notes that
this term is fully defined in section 102(a)(6) of Dodd Frank,
correct? Where in this provision does the Fed get the authority
to override clear statutory language and qualify the definition
of predominantly engaged in financial activities?
A.2. Please see response to Question 1.
Q.3. Mr. Chairman, will you assure this Committee that the
Federal Reserve will abandon this effort at unilaterally
expanding its legislative fiefdom, and comply with clear letter
of the law in Section 102?
A.3. Please see response to Question 1.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
FROM BEN S. BERNANKE
Q.1. As you know, the Volcker Rule becomes effective under the
statute on July 21, 2012, regardless of whether a final
implementing rule has been finalized. As you suggested before
this Committee several weeks ago, the agencies are unlikely to
meet that deadline. Also, in the interim, the Fed has issued
guidance on actions ``banking entities'' should take during the
2-year conformance period in preparation for complying with a
rule that doesn't exist.
With that as background, can you give us a status report on
the interagency negotiations on the Volcker Rule and some idea
as to when the agencies are likely to release the next version?
Can you give us any insight as to what will be released?
A.1. Last year, the Federal Reserve Board (FRB), the Office of
the Comptroller of the Currency (OCC), the Federal Deposit
Insurance Corporation (FDIC), Securities and Exchange
Commission (SEC), and Commodity Futures Trading Commission
(CFTC) (also known as the ``Agencies'') proposed rules to
implement section 619 of the Dodd-Frank Wall Street Reform and
Consumer Protection Act (Dodd-Frank Act); 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. To enhance uniformity in both rules that implement
section 619 and administration of the requirements of section
619, the Agencies have been regularly consulting with each
other in the development of rules and policies that implement
section 619 and will continue to do so.
The Agencies have received over 19,000 comments addressing
a wide variety of aspects of the proposal. The Board and other
rulemaking agencies are carefully reviewing those comments and
considering the suggestions and issues they raise in light of
the statutory restrictions and provisions as we work to
finalize implementing rules. The Agencies are also carefully
considering different options in order to effectively implement
section 619 of the Dodd-Frank Act in a timely manner.
Q.2. Given the sheer number of questions you asked in the
Notice of Proposed Rulemaking (NPR) (several hundred), is it
feasible to go forward at this point with a final rule? Or will
you need to issue a revised NPR with a comment period?
A.2. Please see response to Question 1.
Q.3. I disagree with the premise of designating any entity a
``systemically important financial institution'' (SIFI).
However, it is my understanding that, although not perfect, the
SIFI designation process in the United States is more
transparent than the G-SIFI (Globally Systemically Important
Financial Institution) designation process. I am especially
troubled that confidential company data is being collected to
make G-SIFI determinations without a clearly defined G-SIFI
methodology in place.
Given that the Federal Reserve is a member of the Financial
Stability Board (FSB), which will make G-SIFI determinations,
can you clarify how a company that is designated a G-SIFI but
not designated a SIFI in the U.S. will be regulated? For
instance, how would an insurance company that is currently
regulated at the State level be regulated as a G-SIFI?
A.3. In considering whether to determine that a nonbank
financial company could pose a threat to U.S. financial
stability and subject the company to Board supervision and
prudential standards, the FSOC is required by statute to
consider various factors set forth in the statute that could
result in a different determination (either including or
excluding a firm) by the FSOC under the Dodd-Frank Act than a
determination that may be made by the FSB. For instance, one
factor that the FSOC must consider is the degree to which a
firm is already regulated by another financial regulatory
agency.
The Board and the FSOC are working with the FSB on a number
of initiatives, including the process for identifying globally
systemically important financial institutions and financial
market infrastructures. Furthermore, the Board and the FSOC are
working to ensure the consistency of the approaches used by the
FSB and the FSOC for assessing whether a nonbanking company is
systemically important and to better understand the potential
for different determinations.
Systemically important nonbank firms designated by the FSOC
and bank holding companies with total consolidated assets
greater than $50 billion will be subject to enhanced prudential
standards established by the Board. By contrast, firms that are
not designated by the FSOC and are not bank holding companies
with total assets greater than $50 billion that are designated
as G-SIFIs by the Financial Stability Board would be subject to
internationally agreed-upon standards.
Q.4. In a hearing on March 22, 2012, I asked Treasury's Under
Secretary for International Affairs, Lael Brainard, if she
anticipated a situation where a U.S. company is not designated
a SIFI by FSOC, but is designated a G-SIFI by the FSB, and how
such an institution would be regulated. In her response, she
noted that ``U.S. financial institutions will be regulated in
accordance with U.S. laws and regulations.'' She also said:
``Through its membership on both the Financial Stability
Oversight Council and International Association of Insurance
Supervisors (IAIS) committees involved with the development of
the criteria and methodology, Treasury's Federal Insurance
Office (FIO) is pursuing an international consensus that aligns
the IAIS criteria, methodology, and timing with the Council
(FSOC).''
How will you ensure that the U.S. SIFI designation process
is coordinated with the G-SIFI designation process so that the
integrity of U.S. law is protected?
A.4. Please see response to Question 3.
Q.5. The Federal Reserve's recently proposed capital standards
implementing Basel 3 and section 171 of the Dodd-Frank Act
include an effective date of January 2013 for insurance
companies organized as thrift holding companies. However,
section 171 of the Dodd-Frank Act states that any requirements
of that section shall be effective 5 years from date of
enactment (July 2015).
Can you clarify these effective dates as they apply to
insurers?
A.5. As you know, the Board and the other Federal banking
agencies proposed to revise the risk-based and leverage capital
requirements in three notices of proposed rulemaking (NPRs) and
the Board proposed to apply the revised requirements to SLHCs.
\1\ The proposals in the NPRs, in part, would apply
consolidated risk-based capital requirements to a depository
institution holding company and its subsidiaries. Currently,
capital requirements for insurance companies are imposed by
State insurance laws on a legal entity basis and there are no
State-based, consolidated capital requirements that cover
subsidiaries and noninsurance affiliates of insurance
companies.
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\1\ See, 77 Federal Register 52888, 52909, 52958 (August 30,
2012).
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In developing the NPRs, the Board sought to meet several
legal requirements and policy goals. The NPRs are consistent
with section 171 of the Dodd-Frank Act, which requires
consolidated minimum risk-based and leverage capital
requirements for depository institution holding companies,
including SLHCs, that are no less than the generally applicable
capital requirements that apply to insured depository
institutions under the prompt corrective action framework. The
NPRs are also consistent with the Board's long-standing
practice of applying consolidated minimum capital requirements
to bank holding companies, including those that control
functionally regulated subsidiary insurance companies. This
practice eliminates incentives to engage in capital arbitrage
by booking individual exposures in the legal entity in which
they receive the most favorable capital requirement.
The requirements under section 171 generally apply to
depository institutions holding companies that were not
previously supervised by the Board, including any savings and
loan holding company, beginning on July 21, 2015. Separately,
section 616(b) of the Dodd-Frank Act modified section 10(g)(1)
of the Home Owners' Loan Act (HOLA) to authorize the Board to
establish regulations and orders relating to capital
requirements for savings and loan holding companies. Thus,
section 10(g)(1) of HOLA provides the Board with separate
authority to establish by rule capital requirements for savings
and loan holding companies, apart from the specific minimum
requirements and other limitations that are imposed by statute
in section 171.
Consistent with the Board's authority under section
10(g)(1) of HOLA, the NPRs provide that savings and loan
holding companies would be subject to consolidated minimum
capital requirements beginning on January 1, 2013. The Board
received numerous comments expressing concern regarding this
proposed effective date, including from savings and loan
holding companies. In light of the comments and the wide range
of views expressed during the comment period, the agencies
issued a joint statement on November 9, 2012, noting that the
agencies do not expect that any of the proposed rules would
become effective on January 1, 2013. The Board is considering
carefully all comments received, including potential
implementation challenges for savings and loan holding
companies with insurance company subsidiaries and the
appropriateness of an extended effective date, and will take
them into account over the course of the rulemaking.
------
RESPONSES TO WRITTEN QUESTIONS OF SENATOR KIRK
FROM BEN S. BERNANKE
Q.1. The Federal Reserve's strategy of keeping interest rates
low through ``Operation Twist'' has been aided by global
uncertainty, which has risk-averse investors seeking the safety
of U.S. Treasuries. At the 10-year Treasury note auction on
July 11, investors accepted the lowest yields in history, just
1.459 percent. These low rates have neither spurred economic
growth nor materially lowered unemployment. Rather, they are
creating ``unintended consequences'': (a) Retirees are facing
personal budget cuts as their savings yield next to nothing;
(b) Businesses, which finance much of their working capital on
a floating rate basis, are reluctant to expand; although their
cost of funds is low currently, it is likely to rise just as
any expansion plans are implemented and their working capital
needs rise; and (c) Independent banks are struggling to remain
profitable while managing difficult conditions caused by the
combination of artificially low interest rates, weak commercial
demand, lower debit card fees, and the rising cost and capital
requirements for interest-bearing customer accounts.
Since yields are already at historic lows, what purpose
will further quantitative easing serve? How much lower could
rates reasonably be expected to go with further easing?
A.1.It is true that Treasury yields are very low, but there is
scope for the Federal Reserve to ease financial conditions
further in order to strengthen the economic recovery using
nontraditional policy tools, including purchases of longer-term
assets. The unconventional easing measures undertaken by the
Federal Reserve in recent years have been effective in
contributing to lower longer-term interest rates, higher asset
prices, and generally more accommodative financial conditions
than would have otherwise been the case. More accommodative
financial conditions, in turn, stimulate economic growth by
reducing the cost of borrowing for businesses and households,
and by raising household and business net worth, thereby
boosting aggregate demand and reducing unemployment.
At its December meeting, the Committee announced that it
was increasing policy accommodation by purchasing additional
mortgage-backed securities at a pace of $40 billion per month
and would purchase longer-term Treasury securities at a pace of
$45 billion per month after the completion of the maturity
extension program at the end of the year. The Committee
indicated that unless it sees evidence of a substantial
improvement in labor market conditions in coming months, it
will purchase additional agency MBS securities, undertake
additional asset purchases, and employ its other policy tools
as appropriate until such an improvement is achieved in a
context of price stability. The Committee also indicated that,
as always, it would take appropriate account of the likely
efficacy and costs of its purchases in determining the size,
pace, and composition of such purchases.
The conditioning of purchases on economic outcomes helps to
create an automatic stabilizing effect in financial markets. If
the economy weakens, market participants might expect
additional Federal Reserve purchases and that expectation
should contribute to a further easing in financial conditions.
Conversely, if the economy strengthens, investors might
anticipate that the Federal Reserve will scale back its
purchase of securities and that should contribute to a firming
of financial conditions. Thus, the ultimate extent of the
Committee's purchases, and so their impact on yields, is
uncertain at this point.
Q.2. How would further easing and low interest rates affect
fixed-income seniors unable to move their money into higher
risk investments? Given that this segment of the population is
growing, could depressed consumer demand have negative effects
on the economy?
A.2. The Federal Reserve recognizes that the accommodative
policy the Fed has put in place means that individuals with
savings invested in fixed-income assets may receive lower
interest income for a time. However, the returns on fixed-
income investments, as well as other assets, fundamentally
depend on the strength of the economy. Moreover, the Federal
Reserve's policy actions also boost stock prices, home values,
and other assets that are held by many households, contributing
to higher household net worth than would otherwise be the case.
A stronger economy benefits savers and all Americans in myriad
ways, including stronger income growth, improved job prospects,
and improved access to credit.
Q.3. One major effect of the crisis in Europe is that European
sovereign debt from many countries is no longer considered
riskless. How has this affected demand for Treasuries? What
effect might increased demand have on consideration for further
easing?
A.3. It seems likely that investor concerns about the situation
in Europe have boosted the demand for Treasury securities and
put downward pressure on Treasury yields over recent years. In
making its monetary policy decisions, the FOMC takes into
account all of the factors that it believes are relevant to the
U.S. economic outlook, including the effects of the fiscal and
banking crisis in Europe on financial conditions and U.S.
economic activity. As the FOMC has noted, strains in Europe and
global financial markets represent a significant downside risk
to the U.S. economic outlook. The relatively modest pace of the
U.S. recovery and the associated downside risks, in turn, have
been important factors underlying the FOMC's decision to
provide further monetary policy accommodation over recent
years.
Q.4. The State Budget Crisis Task Force just released a report
identifying ``Six Major Threats to Fiscal Sustainability''
(http://www.statebudgetcrisis.org/wpcms/wp-content/images/
Report-of-the-State-Budget-Crisis-Task-Force-Full.pdf). One key
finding is that ``Underfunded Retirement Promises Create Risks
for Future Budgets.'' One factor that allowed state treasurers
to underfund pensions is assuming unrealistically high rates of
return for retirement investments. If the Federal Reserve
extends ``Operation Twist'' again, what is a realistic rate of
return for conservatively managed pension funds?
A.4. The returns to long-term investments depend crucially on
the strength of economic activity, the rate of inflation, and
the stability of the financial system. The Federal Reserve
conducts monetary policy to foster its statutory objectives of
maximum employment and stable prices. To this end, the Federal
Reserve has reduced the Federal funds rate to its effective
lower bound and has increased the size, and changed the
composition, of its balance sheet in recent years to help make
financial conditions more accommodative. These monetary policy
actions have been motivated by the desire to support a more
robust pace of economic recovery in a context of price
stability. It is in the interest of everyone--including pension
funds and their beneficiaries--to have an economy that is
performing at its highest level of its capacity consistent with
long-term price stability, which, in turn, would increase the
returns on long-term investments.
Q.5. Recent statements by Barclays Bank and the Bank of England
indicate that the LIBOR rate has been subject to manipulation
since 2007. Can market confidence in this rate be restored?
What is the appropriate role for the Federal Reserve in
establishing a credible, transparent market-based interest rate
index that protects American borrowers and lenders?
A.5. Answer not received by time of publication.
Q.6. The Federal Reserve has proposed risk-based capital rules
that do not distinguish between Savings and Loan Holding
Companies engaged primarily in banking and those engaged
predominately in insurance. Considering the differences between
these lines of business and their related risk-based capital
requirements, is it realistic to expect that the complexity of
issues related to this important rule can be adequately
addressed in the current comment period, which is scheduled to
end on September 7?
A.6. As you know, on June 7, 2012, the Board and the other
Federal banking agencies (agencies) proposed to revise their
risk-based and leverage capital requirements in three notices
of proposed rulemaking and to apply the revised requirements to
savings and loan holding companies (SLHCs). \1\ The agencies
jointly extended the comment period from September 7, 2012,
until October 22, 2012, in response to requests from the
public. The Board is considering carefully all comments
received, including potential implementation challenges for
savings and loan holding companies with insurance company
subsidiaries, and will take them into account over the course
of the rulemaking.
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\1\ 1 See, 77 Federal Register 52888, 52909, 52958 (August 30,
2012).
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