[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

                               __________

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



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            COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS

                  TIM JOHNSON, South Dakota, Chairman

JACK REED, Rhode Island              RICHARD C. SHELBY, Alabama
CHARLES E. SCHUMER, New York         MIKE CRAPO, Idaho
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
DANIEL K. AKAKA, Hawaii              JIM DeMINT, South Carolina
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
HERB KOHL, Wisconsin                 PATRICK J. TOOMEY, Pennsylvania
MARK R. WARNER, Virginia             MARK KIRK, Illinois
JEFF MERKLEY, Oregon                 JERRY MORAN, Kansas
MICHAEL F. BENNET, Colorado          ROGER F. WICKER, Mississippi
KAY HAGAN, North Carolina

                     Dwight Fettig, Staff Director

              William D. Duhnke, Republican Staff Director

                       Charles Yi, Chief Counsel
                     Laura Swanson, Policy Director
                  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

                              ----------                              

                         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

                              ----------                              


                         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.
---------------------------------------------------------------------------
     \1\ 77 FR 53060.
---------------------------------------------------------------------------
    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.
---------------------------------------------------------------------------
     \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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