[Senate Hearing 113-6]
[From the U.S. Government Publishing Office]



                                                          S. Hrg. 113-6

 
        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2013

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

                                HEARING

                               before the

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

                    ONE HUNDRED THIRTEENTH CONGRESS

                             FIRST SESSION

                                   ON

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

                               __________

                           FEBRUARY 26, 2013

                               __________

  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              MIKE CRAPO, Idaho
CHARLES E. SCHUMER, New York         RICHARD C. SHELBY, Alabama
ROBERT MENENDEZ, New Jersey          BOB CORKER, Tennessee
SHERROD BROWN, Ohio                  DAVID VITTER, Louisiana
JON TESTER, Montana                  MIKE JOHANNS, Nebraska
MARK R. WARNER, Virginia             PATRICK J. TOOMEY, Pennsylvania
JEFF MERKLEY, Oregon                 MARK KIRK, Illinois
KAY HAGAN, North Carolina            JERRY MORAN, Kansas
JOE MANCHIN III, West Virginia       TOM COBURN, Oklahoma
ELIZABETH WARREN, Massachusetts      DEAN HELLER, Nevada
HEIDI HEITKAMP, North Dakota

                       Charles Yi, Staff Director

                Gregg Richard, Republican Staff Director

                  Laura Swanson, Deputy Staff Director

                    Colin McGinnis, Policy Director

                   Glen Sears, Deputy Policy Director

                  Greg Dean, Republican Chief Counsel

               Mike Piwowar, Republican Senior Economist

                       Dawn Ratliff, Chief Clerk

                     Riker Vermilye, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)
?

                            C O N T E N T S

                              ----------                              

                      THURSDAY, FEBRUARY 26, 2013

                                                                   Page

Opening statement of Chairman Johnson............................     1
    Prepared statement...........................................    37

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

                                WITNESS

Ben S. Bernanke, Chairman, Board of Governors of the Federal 
  Reserve System.................................................     3
    Prepared statement...........................................    37
    Responses to written questions of:
        Senator Warren...........................................    41
        Senator Corker...........................................    44
        Senator Johanns..........................................    45

              Additional Material Supplied for the Record

Monetary Policy Report to the Congress dated February 26, 2013...    47

                                 (iii)


        FEDERAL RESERVE'S FIRST MONETARY POLICY REPORT FOR 2013

                              ----------                              


                       TUESDAY, FEBRUARY 26, 2013

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:15 a.m., in room SD-106, Dirksen 
Senate Office Building, Hon. Tim Johnson, Chairman of the 
Committee, presiding.

           OPENING STATEMENT OF CHAIRMAN TIM JOHNSON

    Chairman Johnson. Today's hearing is with Chairman Bernanke 
on the Federal Reserve's Monetary Policy Report to Congress.
    While progress toward maximum employment has been slow, it 
has been positive and steady, thanks in part to the Fed's 
thoughtful and well-measured monetary actions. Our economy has 
added private sector jobs for 35 straight months. During that 
time, over six million new jobs have been created, but we 
should not sacrifice those gains by slamming on the brakes now.
    Without a fix, automatic spending cuts will take effect in 
just a few days and could send our economy into reverse at a 
time when we should continue moving forward on creating jobs. 
Projections suggest that the sequester will cost us 750,000 
jobs this year. In addition to layoffs for cops, fire fighters, 
and teachers that could devastate our communities, these cuts 
will impact many of our Nation's most vulnerable citizens, 
including kids, seniors, and the disabled. At a time when the 
U.S. faces an array of national security threats, the sequester 
will affect our military readiness.
    It is unacceptable that we are lurching from one 
manufactured crisis to the next, and Americans have had enough. 
These fights are bad for the economy and are making it harder 
for families to make ends meet.
    The steep drops in consumer confidence during the fights 
over the debt limit and the fiscal cliff rival the fallout 
after Lehman Brothers' failure and 9/11. This has consequences. 
If consumers do not spend, businesses will not prosper and hire 
more workers. If businesses are not hiring, our economy will 
not grow. It is that simple.
    We must do all we can to restore confidence in not only our 
financial system, but also in our ability as a country to 
tackle long-term challenges in a responsible, bipartisan 
manner. In addition to Congress acting on a deficit reduction 
plan that is balanced and promotes job creation, there are 
things this Committee can do to help achieve these goals. From 
rigorous oversight, to confirming well-qualified nominees, to 
reauthorizing expiring laws, to reaching consensus on the 
future of housing finance, there are steps this Committee can 
take to promote consumer confidence, provide businesses clarity 
to move forward with long-term plans, and strengthen our 
economic recovery.
    Chairman Bernanke, I look forward to hearing your views as 
both the Fed and the Congress pursue policies supporting our 
Nation's economic recovery.
    I now turn to Ranking Member Crapo.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you, Mr. Chairman.
    Today, we will hear from our Federal Reserve Chairman Ben 
Bernanke, who will testify on the Fed's monetary policy and the 
state of the economy. Mr. Bernanke, I want to thank you at the 
outset for your ongoing initiatives to improve the transparency 
of the Federal Open Market Committee. Because so much is at 
stake for the U.S. economy, the Fed has the responsibility to 
make as much information available to the American people as 
possible on its actions.
    I also thank Chairman Bernanke for his steadfast reminder 
to us that one of the most important risks to our economy is 
our fiscal situation. I completely agree with him. That is why 
I have consistently said that the fiscal reform and economic 
growth should top the list of our priorities in Congress. We 
need to address the Federal spending problem, reform our badly 
broken tax system, and promote a sustainable economic recovery 
that will result in increased jobs.
    Unfortunately, with the fiscal cliff deal completed, some 
officials are looking for an easy way out by claiming that our 
fiscal problems are nearly solved. Nothing could be further 
from the truth. Our economy contracted in the last quarter. Our 
unemployment rate remains far too high. Medicare will be 
insolvent in just over 10 years, and Social Security will be 
insolvent after that. Until we take specific steps to reform 
our entitlements and to make them solvent for generations to 
come and reform our tax code to produce significant, sustained 
economic growth, our fiscal problems are far from solved.
    In addition to our own fiscal situation, the ongoing fiscal 
and banking crisis in Europe also presents substantial risks to 
our economy. In response to unsustainable fiscal policies here 
and abroad, central bankers throughout the world have turned to 
unconventional monetary policies over the past few years. Near-
zero interest rates, large-scale asset purchases, and record-
size central bank balance sheets have become the norm.
    However, some authorities have become increasingly 
concerned that the costs of prolonged easy money policy 
outweigh the benefits. In its annual report released last June, 
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 may delay the return 
to a self-sustaining recovery, but they create longer-term 
risks to central banks' credibility and operational 
independence.
    More recently, the minutes of the Federal Open Market 
Committee's January meeting show that several FOMC members 
expressed concern that the Fed's prolonged easy money policies 
could result in excessive risk taking and threaten the 
financial stability of the United States. These concerns 
warrant serious consideration, given the scale, scope, and 
duration of the Fed's unconventional monetary policies.
    The Fed has kept the target range for the Federal Funds 
Rate at zero to one-quarter percent for more than 4 years. The 
Fed has engaged in multiple rounds of asset purchases, commonly 
referred to as quantitative easing. The Fed is currently buying 
$40 billion of agency mortgage-backed securities per month and 
$45 billion of longer-term Treasury securities per month, for a 
total monthly pace of $85 billion, or an annualized pace of 
more than $1 trillion. And primarily as a result of its large-
scale asset purchases, the Fed has ballooned its balance sheet 
to more than $3 trillion and growing.
    I look forward to hearing from Chairman Bernanke about the 
concerns raised about the risks of the Fed's prolonged easy 
money policies and why they cannot overcome our bad fiscal 
policy.
    I also look forward to hearing from Chairman Bernanke about 
how the uncertainty surrounding the Dodd-Frank implementation 
is hampering our recovery. In particular, what specific 
legislative fixes can be achieved to remove this uncertainty?
    At our last Humphrey-Hawkins hearing, Chairman Bernanke 
confirmed that regardless of Congressional intent, the banking 
regulators view the plain language of the statute as requiring 
them to impose some kind of margin requirement on nonfinancial 
end users of derivatives unless Congress changes the statute. 
Chairman Bernanke also confirmed that the Fed is comfortable 
with an explicit statutory exemption. I look forward to hearing 
Chairman Bernanke's suggestions for other legislative fixes to 
Dodd-Frank that could garner bipartisan support. These and many 
other issues are critical to us and I appreciate again, 
Chairman Bernanke, your attendance at this hearing.
    Chairman Johnson. Thank you, Senator Crapo.
    This morning, opening statements will be limited to the 
Chairman and Ranking Member to allow more time for questions 
from the Committee Members. I want to remind my colleagues that 
the record will be open for the next 7 days for opening 
statements, questions for the record, and any other materials 
you would like to submit.
    Now, I would like to introduce our witness. Ben Bernanke is 
Chairman of the Board of Governors of the Federal Reserve 
System, a position he has held since February 2006. I thank you 
for being here today to testify on the Monetary Policy Report 
to the Congress. Your written statement will be included in the 
hearing record. Chairman Bernanke, you may begin your 
testimony.

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

    Mr. Bernanke. Thank you, Mr. Chairman, Ranking Member, 
Members, I am pleased to present the Federal Reserve's 
Semiannual Monetary Policy Report. I am going to begin with a 
short summary of current economic conditions and then discuss 
aspects of monetary and fiscal policy.
    Since I last reported to this Committee in mid-2012, 
economic activity in the United States has continued to expand 
at a moderate if somewhat uneven pace. In particular, real GDP 
is estimated to have risen at an annual rate of about 3 percent 
in the third quarter, but to have been essentially flat in the 
fourth quarter. The pause in real GDP growth last quarter does 
not appear to reflect a stalling out of the recovery. Rather, 
economic activity was temporarily restrained by weather-related 
disruptions and by transitory declines in a few volatile 
categories of spending, even as demand by U.S. households and 
businesses continued to expand.
    Available information suggests that economic growth has 
picked up again this year. Consistent with the moderate pace of 
economic growth, conditions in the labor market have been 
improving gradually. Since July, nonfarm payroll employment has 
increased by 175,000 jobs per month, on average, and the 
unemployment rate declined three-tenths of a percentage point, 
to 7.9 percent, over the same period. Cumulatively, private 
sector payrolls have now grown by about 6.1 million jobs since 
their low point in early 2010, and the unemployment rate has 
fallen a bit more than 2 percentage points since the cyclical 
peak in late 2009.
    Despite these gains, however, the job market remains 
generally weak, with the unemployment rate well above its 
longer-run normal level. About 4.7 million of the unemployed 
have been without a job for 6 months or more, and millions more 
would like full-time employment but are able to find only part-
time work.
    High unemployment has substantial costs, including not only 
the hardship faced by the unemployed and their families, but 
also the harm done to the vitality and productive potential of 
our economy as a whole. Lengthy periods of unemployment and 
underemployment can erode workers' skills and attachment to the 
labor force or prevent young people from gaining skills and 
experience in the first place, developments that could 
significantly reduce their productivity and earnings in the 
longer term. The loss of output and earnings associated with 
high unemployment also reduces Government revenues and 
increases spending, thereby leading to larger deficits and 
higher levels of debt.
    The recent increase in gasoline prices, which reflects both 
higher crude oil prices and wider refining margins, is hitting 
family budgets. However, overall inflation remains low. Over 
the second half of 2012, the price index for personal 
consumption expenditures rose at an annual rate of 1.5 percent, 
similar to the rate of increase in the first half of the year. 
Measures of longer-term inflation expectations have remained in 
the narrow ranges seen over the past several years. Against 
this backdrop, the Federal Open Market Committee, the FOMC, 
anticipates that inflation over the medium term will likely run 
at or below its 2 percent objective.
    With unemployment well above normal levels and inflation 
subdued, progress toward the Federal Reserve's mandated 
objectives of maximum employment and price stability has 
required a highly accommodative monetary policy. Under normal 
circumstances, policy accommodation would be provided through 
reductions in the FOMC's target for the Federal Funds Rate, the 
interest rate on overnight loans between banks. However, as 
this rate has been close to zero since December 2008, the 
Federal Reserve has had to use alternative policy tools.
    These alternative tools have fallen into two categories. 
The first is forward guidance regarding the FOMC's anticipated 
path for the Federal Funds Rate. Since longer-term interest 
rates reflect market expectations for shorter-term rates over 
time, our guidance influences longer-term rates and thus 
supports a stronger recovery.
    The formulation of this guidance has evolved over time. 
Between August 2011 and December 2012, the Committee used 
calendar dates to indicate how long it expected economic 
conditions to warrant exceptionally low levels for the Federal 
Funds Rate. At its December 2012 meeting, the FOMC agreed to 
shift to providing more explicit guidance on how it expects the 
policy rate to respond to economic developments. Specifically, 
the December post-meeting statement indicated that the current 
exceptionally low range for the Federal Funds Rate will, quote, 
``be appropriate at least as long as the unemployment rates 
above 6.5 percent, inflation between 1 and 2 years ahead is 
projected to be no more than half-a-percentage point above the 
Committee's 2 percent longer-run goal, and longer-term 
inflation expectations continue to be well anchored,'' close 
quote.
    An advantage of the new formulation relative to the 
previous date-based guidance is that it allows market 
participants and the public to update their monetary policy 
expectations more accurately in response to new information 
about the economic outlook. The new guidance also serves to 
underscore the Committee's intention to maintain accommodation 
as long as needed to promote a stronger economic recovery with 
stable prices.
    The second type of nontraditional policy tool employed by 
the FOMC is large-scale purchases of longer-term securities, 
which, like our forward guidance, are intended to support 
economic growth by putting downward pressure on longer-term 
interest rates. The Federal Reserve has engaged in several 
rounds of such purchases since 2008. Last September, the FOMC 
announced it would purchase agency mortgage-backed securities 
at a pace of $40 billion per month, as Senator Crapo noted, and 
in December, the Committee stated that, in addition, beginning 
in January, it would purchase Treasury securities at an initial 
pace of $45 billion per month.
    These additional purchases of longer-term Treasury 
securities replace the purchases we were conducting under our 
now completed Maturity Extension Program, which lengthened the 
maturity of our securities portfolio without increasing its 
size. The FOMC has indicated that it will continue purchases 
until it observes a substantial improvement in the outlook for 
the labor market in a context of price stability.
    The Committee also stated that in determining the size, 
pace, and composition of its asset purchases, it will take 
appropriate account of their likely efficacy and costs. In 
other words, with all of its policy decisions, the Committee 
continues to assess its program of asset purchases within a 
cost-benefit framework.
    In the current economic environment, the benefits of asset 
purchases and of policy accommodation more generally are clear. 
Monetary policy is providing important support to the recovery 
while keeping inflation close to the FOMC's 2 percent 
objective. Notably, keeping longer-term interest rates low has 
helped spark recovery in the housing market and led to 
increased sales and production of automobiles and other durable 
goods. By raising employment and household wealth, for example, 
through higher home prices, these developments have, in turn, 
supported consumer sentiment and spending.
    Highly accommodative monetary policy also has several 
potential costs and risks, which the Committee is monitoring 
closely. For example, if further expansion of the Federal 
Reserve's balance sheet were to undermine public confidence in 
our ability to exit smoothly from our accommodative policies at 
the appropriate time, inflation expectations could rise, 
putting the FOMC's price stability objective at risk. However, 
the Committee remains confident that it has the tools necessary 
to tighten monetary policy when the time comes to do so. As I 
noted, inflation is currently subdued and inflation 
expectations appear well anchored. Neither the FOMC nor private 
forecasters are projecting the development of significant 
inflation pressures.
    Another potential cost that the Committee takes very 
seriously is the possibility that very low interest rates, if 
maintained for a considerable time, could impair financial 
stability. For example, portfolio managers dissatisfied with 
low returns might reach for yield by taking on more credit 
risk, duration risk, or leverage. On the other hand, some risk 
taking, such as when an entrepreneur takes out a loan to start 
a new business, or an existing firm expands capacity, is a 
necessary element of a healthy economic recovery. Moreover, 
although accommodative monetary policies may increase certain 
types of risk taking, in the present circumstances, they also 
serve in some ways to reduce the risk in the system, most 
importantly by strengthening the overall economy, but also by 
encouraging firms to rely more on longer-term funding and by 
reducing debt service costs for households and businesses.
    In any case, the Federal Reserve is responding actively to 
financial stability concerns through substantially expanded 
monitoring of emerging risks in the financial system, an 
approach to the supervision of financial firms that takes a 
more systemic perspective, and the ongoing implementation of 
reforms to make the financial system more transparent and 
resilient. Although a long period of low rates could encourage 
excessive risk taking and continued close attention to such 
developments is certainly warranted, to this point, we do not 
see potential costs of the increased risk taking in some 
financial markets as outweighing the benefits of promoting a 
stronger economic recovery and more rapid job creation.
    Another aspect of the Federal Reserve's policies that has 
been discussed is their implications for the Federal budget. 
The Federal Reserve earns substantial interest on the assets it 
holds in its portfolio, and other than the amount needed to 
fund our cost of operations, all net income is remitted back to 
the Treasury. With the expansion of the Federal Reserve's 
balance sheet, yearly remittances have roughly tripled in 
recent years, with payments to the Treasury totaling 
approximately $290 billion between 2009 and 2012.
    However, if the economy continues to strengthen, as we 
anticipate, and policy accommodation is accordingly reduced, 
these remittances would likely decline in coming years. Federal 
Reserve analysis shows that remittances to the Treasury could 
be quite low for a time in some scenarios, particularly if 
interest rates were to rise quickly.
    However, even in such scenarios, it is highly likely that 
average annual remittances over the period affected by the 
Federal Reserve's purchases will remain higher than the 
precrisis norm, perhaps substantially so. Moreover, to the 
extent that monetary policy promotes growth and job creation, 
the resulting reduction in the Federal deficit would dwarf any 
variation in the Federal Reserve's remittances to the Treasury.
    Although monetary policy is working to promote a more 
robust recovery, it cannot carry the entire burden of ensuring 
a speedier return to economic health. The economy's 
performance, both over the near term and in the longer run, 
will depend importantly on the course of fiscal policy. The 
challenge for the Congress and the Administration is to put the 
Federal budget on a sustainable long-run path that promotes 
economic growth and stability without unnecessarily impeding 
the current recovery.
    Significant progress has been made recently toward reducing 
the Federal budget deficit over the next few years. The 
projections released earlier this month by the CBO indicate 
that under current law, the Federal deficit will narrow from 7 
percent of GDP last year to 2\1/2\ percent in fiscal year 2015. 
As a result, the Federal debt held by the public, including 
that held by the Federal Reserve, is projected to remain 
roughly 75 percent of GDP through much of the current decade.
    However, a substantial portion of the recent progress in 
lowering the deficit has been concentrated in near-term budget 
changes, which, taken together, could create a significant 
headwind for the economic recovery. The CBO estimates the 
deficit reduction policies in current law will slow the pace of 
real GDP growth by about 1\1/2\ percentage points this year 
relative to what it would have been otherwise. A significant 
portion of this effect is related to the automatic spending 
sequestration that is scheduled to begin on March 1, which, 
according to the CBO's estimates, will contribute about six-
tenths of a percentage point to the fiscal drag on economic 
growth this year.
    Given the still moderate underlying pace of economic 
growth, this additional near-term burden on the recovery is 
significant. Moreover, besides having adverse effects on jobs 
and incomes, a slower recovery would lead to less actual 
deficit reduction in the short run for any given set of fiscal 
actions.
    At the same time, and despite progress in reducing near-
term budget deficits, the difficult progress of addressing 
longer-term fiscal imbalances has only begun. Indeed, the CBO 
projects that the Federal deficit and debt as a percentage of 
GDP will begin rising again in the latter part of this decade, 
reflecting in large part the aging of the population and fast 
rising health care costs.
    To promote economic growth in the longer term and to 
preserve economic and financial stability, fiscal policy makers 
will have to put the Federal budget on a sustainable long-run 
path that first stabilizes the ratio of Federal debt to GDP, 
and given the current elevated level of debt, eventually places 
that ratio on a downward trajectory. Between 1960 and the onset 
of the financial crisis, Federal debt averaged less than 40 
percent of GDP. This relatively low level of debt provided the 
Nation much needed flexibility to meet the economic challenges 
of the past few years. Replenishing this fiscal capacity will 
give future Congresses and Administrations greater scope to 
deal with unforseen events.
    To address both the near and longer-term issues, the 
Congress and the Administration should consider replacing the 
sharp front-loaded spending cuts required by the sequestration 
with policies that reduce the Federal deficit more gradually in 
the near term but more substantially in the longer run. Such an 
approach could lessen the near-term fiscal headwinds facing the 
recovery while more effectively addressing the longer-term 
imbalances in the Federal budget.
    Finally, the size of deficits and debt matter, of course, 
but not all tax and spending programs are created equal with 
respect to their effects on the economy. To the greatest extent 
possible, in their efforts to achieve sound public finances, 
fiscal policy makers should not lose sight of the need for 
Federal tax and spending policies that increase incentives to 
work and save, encourage investments in workforce skills, 
advance private capital formation, promote research and 
development, and provide necessary and productive public 
infrastructure. Although economic growth alone cannot eliminate 
Federal budget imbalances in either the short run or the longer 
term, a more rapidly expanding economic pie will ease the 
difficult choices that we face.
    Thank you, Mr. Chairman.
    Chairman Johnson. Thank you for your testimony.
    As we begin questions, I will ask the Clerk to put 5 
minutes on the clock for each Member.
    Chairman Bernanke, what is your assessment--please 
elaborate--of the sequester's impact on our economy in the 
short term if Congress did nothing, and what would be the 
impact if Congress manufactures another crisis with a fight 
over the CR?
    Mr. Bernanke. Well, Mr. Chairman, as I mentioned in my 
remarks, with respect to the sequester, the CBO estimates that 
it would cost about six-tenths a percent of growth in this year 
and the equivalent of about 750,000 jobs, and so it would be a 
drag on near-term economic recovery. More broadly, all of the 
actions taken this year, according to the CBO, would be a drag 
of about 1\1/2\ percentage points, which is quite significant.
    So in that respect, I think an appropriate balance would be 
to introduce these cuts more gradually and to compensate with 
larger and more sustained cuts in the longer run to address our 
long-run fiscal issues.
    As you note, there are a couple of other issues this year, 
including the continuing resolution and the debt ceiling. 
Again, I hope that Congress can work together effectively to 
address these issues with a minimum of uncertainty, because the 
uncertainty itself, of course, is also costly in terms of the 
ability of the private sector to plan, to take risks, and to 
help grow the economy.
    Chairman Johnson. Housing is important to our economic 
growth and the Fed is working on mortgage rules in Basel that 
will have a major impact on housing. Chairman Bernanke, do you 
agree with Governor Tarullo that nothing prevents QRM from 
being the same as QM, and what will you do to ensure new Basel 
rules do not hinder mortgage lending?
    Mr. Bernanke. Mr. Chairman, as you know, the QRM is 
required to be no more broad than the QM, so we have had to 
wait for the QM to be done before we could attack the QRM 
process, although we have put out previous proposed 
rulemakings.
    The QM, of course, is intended to help consumers. The QRM 
is meant to try to strengthen the securitization market. They 
are somewhat different purposes. But I would say, responding to 
your question, that the six agencies which are currently 
discussing the QRM consider the idea of making the QRM 
essentially identical to the QM is a realistic option and is 
one that we are considering.
    Chairman Johnson. Thank you for your answer.
    Also regarding Basel, Ranking Member Crapo and I sent you a 
letter on the potential impact of Basel rules on insurance 
companies and community banks. I look forward to your response.
    Chairman Bernanke, there is an increased focus on 
cybersecurity and the United States, including within our 
financial system. FSOC has noted the issue in its annual 
reports. What is the Fed doing, both with the banks you 
supervise and your own networks, to strengthen financial data 
protection and enhance the cybersecurity of the financial 
sector?
    Mr. Bernanke. Well, Mr. Chairman, as you know, your point 
is absolutely right, that cybersecurity concerns in the 
financial system have become more acute lately. Since last 
fall, there have been a number of so-called denial of service 
attacks on banks, which essentially flood the public-facing Web 
sites and prevent the public from accessing their accounts, for 
example. These are obviously quite disruptive and problematic.
    The leadership on cybersecurity for the financial system is 
being taken, on the one hand, by the Treasury, and on the other 
hand by the various intelligence and securities agencies. The 
Federal Reserve is very much engaged in cooperating with these 
agencies, sharing information, and working with our banks to 
make sure that they have appropriate procedures and oversight 
in place to deal with such problems. But, I have to say, we do 
not have to press them very hard because they recognize it is 
very much in their own interest to do whatever they can to 
prevent these attacks from being effective.
    Chairman Johnson. While some urge the Fed to focus solely 
on inflation, which has been a bigger threat to our economic 
prosperity since 2007, Chairman Bernanke, unemployment or 
inflation, what is the most important step the Fed has taken to 
promote maximum employment?
    Mr. Bernanke. Well, Senator, as you know, we have a dual 
mandate given to us by Congress. That is entirely appropriate. 
Congress should set our objectives and then the Federal Reserve 
should figure out how to meet them. So we are interested both 
in achieving higher levels of employment and in maintaining low 
inflation and price stability.
    Our monetary policy, as I mentioned in my remarks, has been 
quite accommodative in that respect. It is very much like that 
essentially in all other advanced economies. In doing so, we 
have, obviously, in the first instance, provided support for 
the real economy and for job growth through strengthening 
housing, for example, through strengthening the demand for 
automobiles and other durables, through wealth effects and the 
like.
    But I would note that with inflation at or below our 2 
percent target, our policies have also had the effect of 
greatly reducing any risk of deflation, which at the moment 
does not seem like much of a concern, but at certain times, as 
inflation gets close to the zero critical level, that risk 
increases. And keeping inflation from going too low--I realize 
sometimes it is hard to explain to people why inflation that is 
too low is a problem--but if it is too low, you run the risk of 
a Japanese-style situation, where prolonged deflation is a 
barrier to economic growth and stability.
    So our accommodative monetary policy has not really traded 
off one of these against the other. It has supported both real 
growth in employment and kept inflation close to our target. We 
have many other things that we do on the regulatory side and so 
on, but the monetary policy, of course, is the tool that the 
Fed has to try to address that mandate.
    Chairman Johnson. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman.
    Chairman Bernanke, as you mentioned in your testimony, the 
Fed is currently monitoring whether its prolonged near-zero 
interest rate policy could result in excessive risk taking and 
threaten the financial stability of the United States. I am 
interested in what specific metrics you used to evaluate 
whether these risks are increasing.
    Mr. Bernanke. Well, first, Senator, we have greatly 
expanded our resources that we use in the monitoring process. 
We have created a new Office for Financial Stability. We are 
working very intensively with the Financial Stability Oversight 
Council. So the amount of effort we put into this has greatly 
increased. Our internal monitors, in turn, report regularly to 
the Board and they report to the Federal Open Market Committee. 
So our discussions of monetary policy include extensive 
discussions of financial stability issues.
    The kind of metrics that are used include things like 
leverage, are people who are investing taking on too much 
leverage? Are asset valuations out of line according to 
standard metrics? Is interest rate risk or other kinds of risk 
too concentrated? As you know, of course, the Fed is also a 
bank supervisor, so we spend a lot of effort looking at banks 
and other financial institutions, trying to ensure that they 
have appropriate capital, appropriate liquidity, and are 
appropriately managing their risk. And so there's a wide range 
of ways in which we look at this.
    Again, as I indicated, we are watching this very carefully. 
To this point, and I think this is a view shared by others on 
the Committee, while there are things that we really have to 
pay attention to, at this point, they are not of sufficient 
concern that they outweigh the important benefits of trying to 
support a continued recovery.
    Senator Crapo. Well, thank you. I probably would disagree 
with those conclusions. I know a number of my colleagues are 
going to get into this issue a little further, so I am going to 
go on because of the shortness of time.
    I want to talk with you briefly about Dodd-Frank reform. If 
we are able to achieve some bipartisan consensus on steps to 
improve Dodd-Frank, what are some of the provisions that you 
think need clarification or improvement for reconsideration?
    Mr. Bernanke. Well, first, as a general matter, Senator, 
Dodd-Frank is a very big, complicated piece of legislation. It 
addresses many different issues and I am sure there are many 
aspects of it that could be improved in one way or another. I 
recall, in fact, that you yourself had a bill 5 or 6 years ago 
on regulatory reform and simplification----
    Senator Crapo. That is right.
    Mr. Bernanke. ----which was a bipartisan effort to find 
ways to reduce costs without losing the purposes of the 
regulation, and I think something along those lines would be 
very doable in this context. The Federal Reserve would 
certainly be willing to work with you closely.
    In terms of specifics, we would want to do the work, of 
course, but you mentioned in your opening remarks the end user 
issue, clarity on what Congress would like us to do about end 
users, for example. Another area which is proving difficult is 
the push-out provision for derivatives. And I think, more 
generally, I think we all agree that the burden of regulation 
falls particularly heavily on small community banks, which do 
not have the resources to manage those regulations very 
effectively. So I would say as a general proposition that we 
ought to work together to try to find ways to lower that 
regulatory burden on those smaller institutions.
    Senator Crapo. Well, thank you, Mr. Chairman, and I 
appreciate your advice and your expression of willingness to 
work with us on these and others as we move forward to try to 
improve our regulatory climate.
    The last issue, at least that I will have time for in this 
round, is I want to talk about the crisis in Europe. Last week, 
the European Union released its 2013 forecast for the eurozone 
economy and the E.U. economists predict that the eurozone 
economy will shrink for the second year in a row and the third 
in the last five. What specific risks does a prolonged 
recession in Europe present to the outlook for the U.S. 
economy?
    Mr. Bernanke. Well, the risks that we have been facing for 
the last couple of years have been primarily financial, given 
uncertainties about the stability of certain countries' 
sovereign debt, given the risk on, risk off behavior we have 
been seeing in financial markets as news comes in about 
financial developments.
    The European Central Bank has taken a number of important 
steps, including most recently the outright monetary 
transactions, which have helped to bring down the sovereign 
debt yields for the more fiscally challenged countries. That 
has been helpful. There have been a number of other positive 
steps which have generally reduced the financial stresses in 
Europe, notwithstanding the issues raised by the Italian 
election yesterday and today. And so while that remains a 
concern, I think the financial stresses are certainly less 
today than they were over the last 2 years.
    At the same time, as you mentioned, even as the financial 
stresses have moderated to some extent, the European economy 
and the eurozone is in recession. Unemployment is rising, not 
falling. And that affects us in a number of ways, partly 
through the financial sector, but also simply through trade. 
Our economy prospers when we can export and the European market 
is an important market for us and we have noticed a decline in 
our ability to export to Europe. So that is a risk, as well.
    Senator Crapo. Thank you.
    Chairman Johnson. Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman.
    Thank you, Mr. Chairman, for your testimony. Over the last 
several years, the Federal Reserve has been providing stimulus 
to the economy through QE3, through other programs, and 
particularly as we are on the verge of the sequestration, it 
seems that our fiscal policy is not complementary to your 
policy. In fact, contradictory. And as you suggest in your 
testimony, if we could in the short run have a complementary 
policy, that would also add jobs rather than subtract them in 
the short run, add growth that would actually do better in 
closing the deficit and, in fact, provide an opportunity in the 
long run to solve some of the challenging problems.
    In addition, and I would like your comments, if we continue 
to sort of use austerity as our major approach, that, I 
presume, would complicate your ability, as you suggest you can 
do, to, in a measured way, move away from quantitative easing 
at the right time. Could you comment on those points?
    Mr. Bernanke. Well, as I have noted, and I noted again 
today, monetary policy is no panacea, is no cure all, and we do 
not have the ability--we can all disagree on how powerful these 
measures are, and I do think they are effective, but I do not 
think that they can offset the 1\1/2\ percentage points of 
fiscal restraint we are seeing this year, for example. So in 
terms of the near-term recovery, I think there is a sense in 
which monetary and fiscal policy are working at cross purposes.
    Having said that, I want to just be clear that I am not in 
any way denying the importance of long-run fiscal stability. I 
just think that, to some extent, the fiscal policy decisions 
being made are mismatched with the timing of the problem. The 
problem is a longer-term problem and should be addressed over a 
longer timeframe and in a way that, to the extent possible, and 
perhaps it is not entirely possible, but to the extent 
possible, does no harm with respect to the ongoing recovery. 
And that is the kind of balance I hope that the Congress will 
consider.
    Senator Reed. So do I. I may be repeating myself, is that 
if our policies in the short run were complementary, that would 
probably bring down the deficit faster than the current sort of 
cross purposes. Is that your sense, too?
    Mr. Bernanke. Well, certainly the--I do not know if it 
would be literally faster in the short run, because on the one 
hand, you would have fewer cuts and tax increases. On the other 
hand, you have greater growth. So those two factors might be 
going in the other direction.
    But it is true that you get less bang for the buck, so to 
speak, for a given cut or a given tax increase because of the 
effect on short-term growth. So you would get a longer and 
larger long-run deficit impact and do less damage to the growth 
process by looking at this over a longer timeframe.
    Senator Reed. Thank you very much.
    Let me quickly turn to another issue, and that is the Basel 
Committee announced significantly weaker liquidity coverage 
ratio rules, allowing sort of the use of mortgage-backed 
securities as liquid assets, et cetera. Do you intend to follow 
that approach with respect to the Fed, particularly the 
cautionary words you gave us today about risk taking and adding 
leverage to the financial markets?
    Mr. Bernanke. Well, I think that will be our starting 
point. We need to start with the international agreement and 
ask ourselves, to what extent do we need to strengthen it? To 
what extent do we need to customize it for the U.S. context? 
You have to remember that, unlike capital, liquidity 
requirements are a new thing, and there was a significant 
amount of discussion about what was reasonable, what might be 
the side effects of liquidity requirements in other markets, 
and the like. And so there was a bit of iteration in terms of 
what the international agreement was. But we will certainly, of 
course, meet the international agreement, and then we will be 
looking to see whether additional steps or U.S. customization 
is necessary.
    Senator Reed. Finally, and very quickly, Senator Crapo 
touched on the European situation. From afar, it looks like 
their policies of austerity have not helped them grow at all, 
in fact, have complicated their economic situation. Is that a 
fair judgment?
    Mr. Bernanke. Well, austerity is not the only problem. They 
have, obviously, high interest rates and a variety of other 
factors that are affecting their economies. But, again, I would 
say that it is possible to achieve both objectives, short-term 
growth and longer-term financial sustainability, with a more 
judicious combination of short-term and long-term fiscal 
adjustments.
    Senator Reed. Thank you very much, Mr. Chairman. Thank you, 
Mr. Bernanke.
    Chairman Johnson. Senator Shelby.
    Senator Shelby. Thank you.
    Mr. Chairman, welcome again to the Committee. The portfolio 
or the balance sheet of the Fed, you said is $3 trillion, more 
or less, is that right?
    Mr. Bernanke. I did not say, but yes, that is about right.
    Senator Shelby. Is that about right?
    Mr. Bernanke. Yes, sir.
    Senator Shelby. But you said it then, did you not? It is 
about $3 trillion.
    Mr. Bernanke. Yes, sir.
    Senator Shelby. You studied the Fed a long time before you 
ever came to the Fed. Has there ever been that type of balance 
sheet, close to that?
    Mr. Bernanke. I do not think so.
    Senator Shelby. No. OK. Does it concern you, not how you 
add to the balance sheet, but how you might have to deleverage 
the balance sheet, and will that be a challenge for the Fed, or 
could it be?
    Mr. Bernanke. Well, Senator, I should comment that although 
the Fed has not had a balance sheet this size, other central 
banks, like the Japanese, for example, have----
    Senator Shelby. And they have paid for it, too, have they 
not?
    Mr. Bernanke. Well, it depends on your point of view. The 
current Prime Minister thinks they have not done enough.
    Senator Shelby. What do you think?
    Mr. Bernanke. I think that they should try to get rid of 
deflation. I support their attempts to get rid of deflation.
    In terms of exiting from our balance sheet, we have put 
out--a couple years ago, we put out a plan. We have a set of 
tools. I think we have belts, suspenders, two pairs of 
suspenders. We have different ways that we can do it. So I am 
not--I think we have the technical means to unwind it at the 
appropriate time. Of course, picking the exact moment to do it, 
of course, is always difficult. You know, you want to withdraw 
the support at the right time, not too early, not too late. 
That is always a judgment call.
    But in terms of the ability to get out and to normalize our 
balance sheet, we have, again, a set of tools, which I would be 
happy to go into, if you like, but which will allow us to 
normalize policy either by selling assets or by retaining 
assets and doing other things, like raising the interest rate 
we pay on reserves.
    Senator Shelby. Do you think you will grow to a $4 trillion 
balance sheet?
    Mr. Bernanke. Well, we do not have--we did not announce any 
number. What we are doing is we are looking--we are tying our 
asset purchases to the state of the economy. We want to 
continue purchases until we see a substantial improvement in 
the outlook for the labor market, conditional on inflation 
remaining stable. We are also, as I mentioned in my remarks, we 
are looking at the costs and benefits, including the financial 
stability issues that Senator Crapo alluded to. So we do not 
have--we have not given a specific number, but we are certainly 
paying close attention to all of these issues.
    Senator Crapo mentioned the transparency of the Fed. We are 
having this debate in public. You may have noticed that many 
Members of the Committee talk in public. We want everyone to 
understand that we are looking at all these issues. We are 
taking them all into account. And we are trying to do the right 
balancing of our objectives.
    Senator Shelby. Is your portfolio public?
    Mr. Bernanke. Yes, sir.
    Senator Shelby. It is public. In other words, the $3 
trillion value of your portfolio, it is public as to what 
securities you have and how they are doing, performing and 
nonperforming, is that----
    Mr. Bernanke. They are all performing, every single one. I 
mean, they are all Treasuries and Treasury-guaranteed agency 
securities.
    Senator Shelby. Just about all of them are Treasury and 
Treasury-related securities?
    Mr. Bernanke. By law, we can only buy Treasuries and 
agencies.
    Senator Shelby. And they are all performing right now?
    Mr. Bernanke. A hundred percent.
    Senator Shelby. OK. I want to discuss Basel III--I just 
have a minute. Where is Basel III as far as implementation in 
Europe and the U.S.? Bring us up to date.
    Mr. Bernanke. Yes, sir----
    Senator Shelby. Because I think this is a very important 
regulatory challenge for everybody.
    Mr. Bernanke. Right. Well, as you know, we put out a 
proposed rule on Basel III. We received lots of comments. We 
work to those comments. We have continued to talk to our 
international partners and we are planning to have a final rule 
out on Basel III--I cannot give you an exact date, but 
somewhere in the middle of this year, and with the aim of 
getting the implementation of Basel III during 2013.
    I would point out, also, that as far as we can tell through 
our stress tests and other measures, virtually all of our banks 
are already well on track to meet the Basel III requirements. 
So it is not a question of the banks not being adequately 
capitalized. They are already either at or about to reach the 
Basel III capital levels.
    Senator Shelby. What about Europe and their banks?
    Mr. Bernanke. Europe is also in the process of implementing 
Basel III. Their banking system is weaker, I think. It has 
strengthened some in recent quarters. We are discussing with 
them some of the details of their plans, some of which differ 
from the international agreement, in our view. But they are 
also in the process of implementing this agreement.
    Senator Shelby. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman.
    First, I want to welcome Senator Crapo as our new Ranking 
Member and look forward to working with you on the Committee. 
And to the other new Members of the Committee, welcome. It is a 
great Committee with a great group, and I hope we will have a 
good, productive time under the Chairman's leadership.
    OK. My first few questions are about sequestration, and 
then I want to talk a little about Italy.
    Estimates suggest that letting sequester take effect could 
reduce the GDP by as much as half a point over the remainder of 
the year. I first want to know if it is--I am going to ask you 
a series and you can answer them. Is that a fair estimate?
    Instead of stopping sequestration, some have suggested 
letting the full amount of cuts take effect, but rearranging 
the cuts rather than imposing them across the board. In your 
opinion, would this reshuffling mitigate the negative effect of 
GDP growth in any meaningful way this year or next, or would 
the net effect on short-term GDP be more or less the same since 
the total amounts of cuts would be the same?
    And my second question on sequestration is this. It goes 
into effect Friday. There is some debate about how quickly the 
cuts will take place and how quickly the impact on jobs and the 
economy will be felt. CBO says sequestration will cost 750,000 
jobs. When do you think we will start seeing the impact in the 
job market? In the March job numbers? In April? When? Those are 
my questions on sequestration.
    Mr. Bernanke. Sure. The six-tenths on GDP growth in 2013 is 
a CBO number, and we get very similar results to that. I think 
that is a reasonable estimate.
    In terms of whether or not rearranging the cuts would be 
beneficial, it could be beneficial from the point of view of 
more efficient allocation of the cuts or cuts that are more 
consistent with the preferences of Congress, but that, of 
course, is a Congressional decision. I have no input there 
other than to say that I think the near-term effect on growth 
would probably not be substantially different if you did it 
that way.
    In terms of the effects on jobs and employment, the 
spending implications of the sequester take place over a period 
of time, so I----
    Senator Schumer. Mr. Chairman, you did not answer the 
second one. I asked you, would it--regardless of the political 
preferences that the Congress might have--would the 
rearrangement, if there is flexibility, affect economic growth 
in any real way----
    Mr. Bernanke. Oh, sorry----
    Senator Schumer. ----if the cut level is the same?
    Mr. Bernanke. Not significantly. It would be about the 
same, I think.
    Senator Schumer. Got you. Good.
    Mr. Bernanke. In terms of the impact, the sequestration 
takes place over time. Furloughs take place over time. Spending 
cuts take place over time. So I would not expect to see a big 
impact immediately. I think it would probably build over a 
period of months.
    Senator Schumer. Right. One of my colleagues--I do not want 
to steal his thunder, he is not here--but at a meeting earlier 
described it like the metaphor of the frog who jumps into a pot 
and the water just starts boiling, and you do not feel it at 
first, but if you stay in that pot, you are going to be singed 
pretty badly. Is that a fair analogy?
    Mr. Bernanke. Well, again, I think that it would take 
effect over a period of time, and remember, it is also in 
conjunction with the other measures that have been taken this 
year, as well.
    Senator Schumer. Yes. Thank you.
    The next question is on Italy. So the markets reacted quite 
nervously, shall we say, to the elections in Italy and the idea 
that they might not be able to form a Government, or might form 
a Government that would be less willing to go along with the 
present economic policies. My question is, A, what do you think 
of that, but B, more importantly, what is the exposure of our 
American financial institutions to Italy's debt? How 
dangerous--let us say--let us take the worst case scenario and 
let us say they cannot form a Government and they go through a 
little bit of what Greece or Spain has. How big an effect would 
that have on the stability--not on the world economy, not on 
our selling to Italy, but on the stability of our American 
financial institutions?
    Mr. Bernanke. Well, the market is reacting, first and 
foremost, to uncertainty. It does not know which way the 
Italian Government is going to go and how those policies will 
be affected.
    I am not an expert in Italian politics, but I do not think 
that any of the candidates have outright rejected either 
staying in the Euro or maintaining the policies that are being 
required of Italy in order to continue to receive--you know, in 
order to continue to be in the eurozone. But, again, there is a 
lot of uncertainty there to see what happens.
    Italy is unusual in that its current deficits are not very 
large, but it has a very large outstanding debt, and so there 
is a lot of Italian debt held around the world. Our 
assessments, going back, is that our banking exposure to 
Italian and Spanish debt is moderate, that it would be 
meaningful, but--again, I am not forecasting in any way--would 
not inflict serious damage on our financial institutions.
    There are, of course, also money market funds that lend a 
lot of funds to European banks, including Italian banks, and 
those are connected. The fate of those institutions is 
connected to the fate of the fiscal situation.
    But, again, I think that the main effects would be more 
indirect. I think--and again, I want to emphasize, this is 
totally hypothetical--that serious concerns about, say, the 
ability of Italy to remain in the Euro would probably have much 
broader effects on other asset classes--stock market, bond 
yields around the world, bank stocks, et cetera--and those 
effects would be more unpredictable and more concerning 
probably than direct losses and exposures in terms of Italian 
debt holdings.
    Senator Schumer. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Corker.
    Senator Corker. Thank you, Mr. Chairman.
    When the Fed decided that it was going to stimulate a 
global currency war as it did, did you embark on that thinking, 
well, our country is in trouble and let us sort of the heck 
with everybody else, or did you think it would leverage the 
wealth effect, if you will, if everybody had a race to the 
bottom? I know the Fed has been really purposeful in trying to 
create this sort of faux wealth effect. Did you think it would 
multiply your efforts?
    And speaking to that, so overall wealth effect, I know you 
all do calculations all the time, but could you tell us exactly 
what sort of the wealth effect is, the part of it that is not 
real, that if you were to stop doing what you are doing as it 
relates to monetary supply today, how much of a diminishment in 
national wealth would take place?
    Mr. Bernanke. On the first question, we are not engaged in 
a currency war. We are not targeting our currency. The G7 put 
out a statement which was very clear that it is entirely 
appropriate for countries to use monetary policy to address 
their domestic objectives, in our case, employment and price 
stability. Our position is that our expansionary monetary 
policies, which are being replicated, of course, in other 
industrial countries, are increasing demand globally and 
helping not only our businesses but also the businesses in 
other countries that export to us. And so this is not a 
``beggar thy neighbor'' policy. It is one that benefits our 
trading partners.
    Senator Corker. But the wealth effect is something you have 
tried to stimulate here, and I wonder if you could tell me----
    Mr. Bernanke. Yes, that----
    Senator Corker. ----how much wealth diminishment would take 
place if you were to, if you will, move away from the punch 
bowl.
    Mr. Bernanke. Well, there would be some, but I would point 
out that if you look at the stock market, for example, that the 
so-called equity premium, the risk premium associated with 
stock prices, is actually quite wide. In other words, stock 
prices by that metric do not appear over-valued, given earnings 
and given interest rates. Now, if interest rates went up some, 
that would have some effect on stock prices.
    But the point here is not to create what you call a faux 
wealth effect. The point here is to stimulate the economy, 
create some forward momentum in growth and employment, and 
that, in turn, shows up in earnings and that creates a genuine 
increase in wealth, the same with house prices.
    Senator Corker. So I think that, you know, I do not think 
there is any question that you would be the biggest dove, if 
you will, since World War II. I think that is something you are 
rather proud of. And we have a Federal Government that is 
spending more relative to GDP than at any time since World War 
II. Those are working well together in that the Fed is actually 
purchasing a large portion of the new debt issuances as we live 
beyond our means, and so it is working very well together in 
that regard.
    I am just wondering if you all talk at all in your meetings 
about the degrading effect that is having on our society and 
how it is basically punishing people who have done the right 
things and throwing seniors under the bus and others that have 
saved money. Do you all ever talk about the longer-term 
degrading effect of these policies as we try to live for today?
    Mr. Bernanke. I think one concern we have is about the 
effect of long-term unemployment and people who do not have 
jobs for years. That means they are never going to acquire 
skills. They are never going to be a productive part of our 
workforce. So the jobs part is very important.
    You called me a dove. Well, maybe in some respects, I am, 
but on the other hand, my inflation record is the best of any 
Federal Reserve Chairman in the postwar period, or at least one 
of the best, about 2 percent average inflation. So we have 
worked on both sides of the mandate and we are trying to 
achieve a stronger economy for everybody. I do not think there 
is any degrading going on.
    You mentioned, in particular, the issue of savers, and I 
think that is an important issue. I would just point out that 
if we tried to raise interest rates from, say, the current 10-
year yield is 2 percent--if we tried to raise it to three or 
four or 5 percent while the economy was still weak, it could 
not be sustained. Our economy is not weak enough to sustain 
high real returns to savers. If we tried to do that, we would 
throw our economy back into recession and we would have low 
interest rates like the Japanese do. The only way to get 
interest rates up for savers is to get a strong recovery, and 
the only way to get a strong recovery is to provide adequate 
support to the recovery. So I do not agree with that premise.
    Senator Corker. Do you concern yourself at all with just 
the whole notion of being perceived--you know, we watch 
regulatory capture take place here, where basically the 
regulators end up working for the people that they regulate. 
You know, we have TARP, which most people who voted felt like 
that was a needed thing during a crisis, and then we have had 
this easy money policy which really allowed the big 
institutions, especially on Wall Street, to really reap 
tremendous benefits in the early stages without doing anything. 
And then you are getting ready, I guess, in a few years, as you 
alluded to, when interest rates rise, to basically have to 
print money to sell securities at losses and then pay interest 
on reserves, which people have pointed out, and I think all 
have talked about, is going to be billions and billions of 
dollars going to these institutions that, again, you regulate. 
Do you concern yourself at all with the Fed being viewed as not 
as independent as it used to be and working so closely with 
many of these institutions that you regulate?
    Mr. Bernanke. Well, we are concerned about perceptions, 
that is true, but none of the things you said are accurate. For 
example----
    Senator Corker. Well, yes, they are.
    Mr. Bernanke. Well, so to take the case of paying interest 
on reserves in the exit, for example, that is, number one, that 
is beneficial for the taxpayer because on the left hand side of 
the balance sheet is reserves, but on the right hand side is 
the securities that we hold, which pay a higher interest rate 
than the reserves. So by doing that, we actually make a profit 
which we remit to the Treasury.
    Senator Corker. Well, it is really good for the 
institutions.
    Mr. Bernanke. We are not helping the banks. We are not 
helping the banks because----
    Senator Corker. No, when you exit. When you begin to draw 
the money supply in, it is going to be very, very beneficial to 
these institutions.
    Mr. Bernanke. Why?
    Senator Corker. Oh, they are going to be yielding huge 
returns on their reserves as you pay the----
    Mr. Bernanke. We will be paying market rates. We will be 
paying exactly what they can be getting in the repo market, in 
the commercial paper market, anywhere else. There is no subsidy 
involved.
    Senator Corker. OK.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    Chairman Bernanke, thanks for your testimony. You mentioned 
the housing market and that being important. It has always been 
one of the drivers of our economic recovery. And in that 
respect, Senator Boxer and I have reintroduced the Responsible 
Homeowner Refinancing Act, which would remove barriers to 
refinancing for borrowers with GSE mortgages and have a history 
of paying their mortgage on time. In the State of the Union, 
President Obama said too many families who have never missed a 
payment and want to refinance are being told no and urged the 
Congress to act.
    In that respect, could you discuss the benefit to both 
individuals and the national economy of enabling more families 
to refinance mortgages at today's historically low interest 
rates?
    Mr. Bernanke. Well, on the side of the borrowers, if they 
are able to refinance, then they will have, obviously, lower 
payments, lower debt burdens, and to some extent, more income 
and ability to spend. I guess the question on the other side is 
whether there are needed subsides or other costs and how large 
those would be. That would be the tradeoff I would look at.
    But it is true from the borrower's point of view, being 
able to refinance at a lower rate is going to increase the 
chance that you can stay in your house and increase your 
income.
    Senator Menendez. Would we not be, in essence, solidifying 
an entire universe of responsible, so far responsible, 
borrowers to be able to ensure that they can continue to be a 
responsible borrower, be able to avert any movement toward 
foreclosure and create an economic stimulus, because if I have 
been patching the roof on my house because I do not have the 
money to fully repair it and now I am paying $300 or $400 less 
a month, I am going to have the wherewithal to spend that money 
in an economy that would ultimately have a ripple effect? Would 
that not be a fair statement?
    Mr. Bernanke. Well, Senator, as you know, I do not like to 
endorse specific legislative proposals. In this case----
    Senator Menendez. Well, forget about the proposal. Just the 
question in general of the possibility of refinancing at 
historically lower rates.
    Mr. Bernanke. Again, from the borrower's point of view, 
that is clearly better. They will have lower payments. They 
will have more income, discretionary income, a better chance of 
staying in their house. And I guess the question is, what 
implications would it have on the lenders' side or on the 
fiscal side. Would there be some money coming in from the 
Government to offset it on the other side, would be the 
question I think you would have to look at. But your basic 
point, would it help borrowers, obviously, it would.
    Senator Menendez. Let me ask you this. With reference--you 
said in your testimony--I do not know if you verbalized this, 
but I read it--it says, the sizes of deficits and debt matter, 
of course, but not all tax and spending programs are created 
equal with respect to their effects on the economy. To the 
greatest extent possible, in their efforts to achieve sound 
public finances, fiscal policy makers should not lose sight of 
the need for Federal tax and spending policies that increase 
incentives to work and save, encourage investments in workforce 
skills, advance private capital formation, promote research and 
development, and provide necessary and productive public 
infrastructure.
    With that view being your statement, is not sequester--
which is something I did not vote for because I saw exactly 
where we were going to be headed--is not the way sequester 
takes place totally in contrary to that view?
    Mr. Bernanke. I think there is a tendency, Senator, when 
you are thinking about the budget and the deficit, to just talk 
about total spending, total taxes, and I am saying, and I think 
it is consistent with your point, that it is also very 
important whether the tax policy is a good tax policy, whether 
the spending is productive spending that increases the 
productive capacity of our economy or achieves desirable social 
goals. So I hope it is not too controversial to say that I 
think the Congress ought to think carefully about how it taxes 
and spends and try and achieve the best outcomes it can.
    Senator Menendez. Well, in sequester, you have across-the-
board cuts.
    Mr. Bernanke. That is right.
    Senator Menendez. Now, if you are in the private sector and 
you lost revenue, either you try to make up that revenue or, if 
you had to make cuts in your business, you would make it in 
accordance with what would pose you for growth again. So it 
might be in the context of one company human capital. In 
another company, it might be technology, whatever.
    Mr. Bernanke. Mm-hmm.
    Senator Menendez. Across-the-board cuts are indiscriminate 
and, therefore, do not have the balance that you suggest is 
necessary. Would that be a fair statement?
    Mr. Bernanke. That is fair, but the question is, will the 
Senate and the Congress be able to agree on how to replace the 
sequester with a different set of programs? If they can, 
obviously, if they can find a better combination, obviously, 
that would be better for our economy.
    Senator Menendez. Well, it would certainly be more 
desirable, assuming that that agreement could be achieved, than 
a meat axe approach, across the board, regardless of 
understanding the very issues that you raise. How do you create 
policies that create incentives to work and save, encourage 
workforce skills, capital formation, and what not.
    Mr. Bernanke. I agree.
    Senator Menendez. Thank you.
    Chairman Johnson. Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman, and thank you, 
Chairman Bernanke, for joining us.
    I would just like to follow up for a moment on the point 
that the Senator from New Jersey was making, because I think, 
if I understood the gist of what he was saying, we might have a 
lot of agreement on this, and that is whether we like it or 
not, it is certainly possible and actually looks quite likely 
that the sequester will at least begin. And as it is currently 
codified, it is without regard to any sense of what are higher 
and lower priorities in the different agencies that would be 
affected.
    It is hard to imagine that that is the optimal way to go 
about cutting spending. It is impossible for me to believe that 
all spending is equally meritorious and that every category of 
spending within every agency has equal merit and equal 
priority. And so it seems to me that the most sensible way to 
go about this would be to give some flexibility to the people 
who are closest to these spending decisions--the agency heads, 
the Administration, the OMB--so that they can at least make the 
cuts that are least disruptive. Some cuts are more disruptive 
than others, and it just seems that it could be less disruptive 
to our economy if they had a chance to do this through a 
thoughtful process than if it has to be done uniformly across 
the board. Does that make some sense?
    Mr. Bernanke. Yes, sir.
    Senator Toomey. Thank you. Another point about the 
sequester I just have to make--I was not going to get into 
this, but I just have to strongly disagree with the notion that 
we have some kind of severe austerity program that is about to 
kick in. We have a Federal Government that has doubled in size 
in the last 10 years, 100 percent growth in total spending. The 
sequestration contemplates 2.5 percent budget authority 
reduction, which, as you know, about half of that would be 
actually spent in this fiscal year. So we are talking less than 
1.3 percent of Federal spending and outlays that would be 
curbed.
    The fact is, if the sequestration fully goes into effect, 
in fiscal year 2013, the Federal Government will spend more 
money than it did in 2012. It is hard for me to understand that 
as draconian spending cuts and austerity. And, by the way, by 
my math, the actual outlay is a reduction that is equal to 
about one-quarter of 1 percent of GDP. How that has a 
disastrous impact on GDP growth escapes me.
    And, frankly, the idea that we would somehow postpone it 
and promise that we will make cuts in the future, I think the 
credibility of those promises would be worth zero and our 
economy would respond in a very adverse way, because it would 
see that we have absolutely no willingness, no political 
ability, to begin even the slightest imposition of fiscal 
discipline. And so I think that has very negative implications.
    My specific question is for you on monetary policy, Mr. 
Chairman. You talked about the fact that inflation has not 
manifested itself as a problem by conventional measures at this 
point. I take your point. To what extent are you concerned 
about asset bubbles? There are people who think we have bubbles 
in the works right now in Treasury securities and agricultural 
real estate, some even in the equity markets. How do you know 
when there is a bubble, and how concerned are you that this 
absolutely unprecedented monetary policy could manifest itself 
in inappropriate asset appreciation?
    Mr. Bernanke. It is a concern, as I said in my remarks. We 
are approaching it two ways. First, we are putting a lot of 
effort into measuring, monitoring, assessing asset prices and 
financial activities. Second, we are trying to make sure that, 
to the extent that there may be some frothiness in a particular 
asset class, that the holders of those assets are prepared to 
deal with the losses. So, for example, banks have twice as much 
capital today than they did a few years ago and we stress them 
according to different possible scenarios where asset prices 
move sharply and ask, would they still be able to lend and be 
stable.
    Senator Toomey. And I have got very little time, so I 
acknowledge that, but I think you perhaps would agree that it 
can be very difficult to know when a bubble is really forming 
and it is getting frothy as opposed to being driven by 
fundamentals.
    And the other concern that I have, as you mentioned 
earlier, I think, in conversation with Senator Shelby and 
perhaps Senator Corker, that you are confident that you have 
the ability to unwind the very large balance sheet that you 
have got. There is no question, you have the ability to unwind. 
What worries me is the impossibility of knowing the impact of 
the unwind.
    For instance, just the suggestion of maybe a little bit 
more dissent within the FOMC than people previously thought 
existed precipitated a significant sell-off in equities a week 
or two ago. What would the impact be of actually having to 
liquidate a big portion of your holdings on the bond market, on 
the equity markets?
    Mr. Bernanke. We do not anticipate having to do that. We 
think that we can----
    Senator Toomey. Not ever?
    Mr. Bernanke. We could exit without ever selling by letting 
it run off, and we could tighten policy by raising interest 
rates that we pay on reserves. That would be one strategy, for 
example.
    In any case, we have said that we will sell slowly, with 
lots of notice, and we will, of course, also be offering our 
forward guidance about rates so that there will not be a shift 
in rates, expectations on the part of the market. So we are 
giving a lot of thought to these issues.
    Senator, if I could just make one very quick point, there 
is no risk-free approach to this situation. I mean, the risk of 
not doing anything is severe, as well. So we are trying to 
balance these things as best we can.
    Senator Toomey. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Warner.
    Senator Warner. Thank you, Mr. Chairman, and Chairman 
Bernanke, thank you for your work and your efforts to, as I 
think we all have some concerns, take extraordinary actions, 
oftentimes because, at least to date, it seems like we have 
failed to keep up our end of the bargain to put in place the 
kind of balanced, comprehensive, phased in deficit reduction 
plan that you have called for and many of us have worked on for 
years.
    I would add, as well, that every one of those plans from 
Simpson-Bowles on had a revenue component that was 
substantially higher than the revenue secured on the New Year's 
Eve deal. I would also acknowledge all of those had an 
entitlement reform component that also has not been part of the 
agreements to date.
    I do want to come back at one level on the sequestration, 
because I heard some of my colleagues say the hit to the 
economy of sequestrations, which was set up to be the stupidest 
option possible, such an outrageous option that rational people 
would never allow it to come to pass, we look at that kind of 
top-line number and its effect it would have on the economy, 
and one of the things--I know you have got great folks who do 
analysis--whether you have been able to kind of dig in at a 
kind of level below--beyond just the kind of top-line cut, the 
failure to have it phased in, the failure, for example, to have 
a balance with some revenue additions, but to actually get to 
the level of granularity where, in many cases, because of this 
across-the-board approach without any prioritization, 975 
separate line items in the Navy not of equal value to the 
taxpayer or to our defense, where in many cases we will 
actually be costing the taxpayer more money by these cuts, 
where we will be either in one case breaking volume contract 
purchases on--not just on the DOD side, but on other sides, or 
the cases where--I had a university president here today with 
me where NIH grants that may have had three or 4 years' worth 
of research where the last year of research now cannot be let 
and consequently all of the previous work kind of goes down the 
drain. Or, while we talk about the economic costs of 
furloughing individuals, whether you have been able to do the 
analysis and say what that downstream might mean when it is 
meat inspectors or poultry inspectors which then might have a 
subsequent driving up of prices to consumers because not as 
much food gets into the grocery store.
    Has your analysis taken on the kind of, not just top line, 
but the kind of the extra added stupidity value that was not 
built into this legislation?
    Mr. Bernanke. Well, I agree with a couple of previous 
speakers on both sides that a thoughtful approach that looked 
at all these issues would be better if it could be agreed upon 
than a just across-the-board approach. But we do not get into 
line items and specific programs.
    Senator Warner. And I agree. Top line, the number is going 
to have an enormously detrimental effect, and again, why I 
think we need balance. But I would argue that there is a 
perhaps stupid and slightly less stupid way and I am, I think, 
only digging into some of the--literally some of the 
absurdities that will take place. And, actually, some of the 
costs that the taxpayers will incur under the guise of, quote-
unquote, ``cutting'' is pretty remarkable.
    I want to come back to--I have a host of questions, and my 
time is quickly going away, as well--two other items. One, a 
lot of conversation for those of us who have been wrestling 
with the fiscal issues on any kind of historic basis. Clearly, 
we are at historic spending levels, historically high spending 
levels. We are also at historically low, the last 50 years, at 
least, revenue levels.
    One of the things that sometimes is cited is, well, our 
goal ought to be a 50-year running average of what our revenue 
should be as a percent of GDP. I guess I just really wonder, 
with the demographic bulge that we have, with the aging of our 
population, that even those of us who have been very strong 
proponents of major entitlement reform, do you really think 
that kind of a backwards-looking 50-year historic revenue 
target is appropriate as an economist when you look at both our 
aging population and the kind of demographic bulge of the baby 
boom coming in, even with meaningful entitlement reform?
    Mr. Bernanke. Well, the way I think about it is in terms of 
debt-to-GDP ratio. As I mentioned in my remarks, we had a 
national asset of a 40 percent debt-to-GDP ratio before the 
crisis and we have lost a lot of that asset. And given what is 
happening, you know, 10, 20, 30 years out, we should be trying 
to buildup over the next decade some fiscal capacity to deal 
with it.
    Senator Warner. My time is up, but just would you say what 
that debt-to-GDP goal should be going forward? You have made 
that comment at various times----
    Mr. Bernanke. I do not think there is a magic number, but 
historically, we have not been at 75 percent at any time since 
just after World War II. So if we can bring it down from here 
some, it would be helpful, I think.
    Senator Warner. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Coburn.
    Senator Coburn. Thank you, Mr. Chairman, for being here. I 
appreciate your work.
    Just a comment on Senator Warner. The revenue that was 
passed was certainly less than what Simpson-Bowles had agreed 
to, but I would remind my colleague, Simpson-Bowles revenue was 
used to lower tax rates to stimulate the economy, not to raise 
taxes and not stimulate the economy. And what is outrageous is 
that we have not done anything to address our long-term 
problems. And I know my colleague from Virginia has been very 
effective in working across the aisle to try to accomplish 
that.
    My questions really have to do with QE. Do you think--is 
there a diminishing return on your efforts at quantitative 
easing, in terms of its effect?
    Mr. Bernanke. That is a good question when we have debated. 
On the one hand, the first round in 2009 had some very 
substantial benefits in terms of market functioning. Markets 
were in turmoil. Our purchases helped calm markets and set the 
stage for recovery in financial markets. Of course, we do not 
have quite that situation today.
    On the other hand, there are some things working in the 
other direction. For example, credit markets are more open 
today. Banks are lending more today. And so in some sense, the 
low interest rates can pass through more easily today than they 
could have a couple years ago.
    So that is a good question. We do not know exactly which 
way it goes, but I think, as I said in my remarks, I think 
there is pretty good evidence that 3.5 percent mortgage rates 
are one of the reasons why housing looks like it is turning 
around, low auto rates one of the reasons why car sales are up. 
So whether it is bigger or less, I am not sure, but it does 
seem to be having some positive benefits in terms of growth.
    Senator Coburn. Now that we have Japan actually pretty well 
duplicating some of our efforts in terms of QE to fight 
deflation, which I agree is a proper goal for them--they have 
struggled with that for 20 years--do you worry at all, now that 
the European countries have done a quantitative easing, in 
effect, Japan has done it, the Bank of China has done it, we 
have done it, that the competitive ratio or the net competitive 
differences might divert away and we see this in terms of trade 
protectionism in terms of the international markets?
    Mr. Bernanke. Well, first, Senator, you make a good point 
that the Fed is not at all extraordinary. In terms of balance 
sheets, in terms of long-term interest rates, we are very 
similar to a lot of other countries.
    As I was saying before, we do not view monetary policy 
aimed at domestic goals as being a currency war. It is not like 
putting tariffs on your imports so that you can ``beggar thy 
neighbor'' to the benefit of your domestic industries. That is 
not what we are doing. If all the major economies that need 
support provide stimulus and extra aggregate demand, that is 
mutually beneficial because, for example, China depends on the 
strength of Europe and the U.S. as their export market, and we, 
too, depend on other countries, as well, as a market for our 
goods. So this is, I think, a positive sum game, not a zero sum 
game, that we have here.
    Senator Coburn. But there was some concern in the last G20 
meeting in terms of this target of the end being at 110 instead 
of 90--instead of 78, like it was 90 days ago, or maybe longer. 
But there is some concern that currencies can get out of 
balance and that will have a significant impact on trade. Would 
you agree with that?
    Mr. Bernanke. Well----
    Senator Coburn. There was certainly discussion in the 
press.
    Mr. Bernanke. There was certainly discussion of the issue. 
The emerging market economies, which are at full employment in 
many cases, are unhappy because low interest rates in the 
advanced economies give them a choice they do not like. Either 
they have to accept low interest rates, which they feel causes 
inflation or problems in their own economy, or, alternatively, 
they have to raise--let their exchange rate appreciate, which 
hurts their export market. So they have had some concerns with 
accommodative monetary policy in advanced economies, in 
general, but I do not think Japan really raises a special case, 
notwithstanding the rhetoric. Of course, we have not seen what 
they are going to do yet. I mean, they have not even officially 
appointed the new Governor. But, presumably, what they are 
going to do is monetary policy aimed at domestic objectives and 
not specifically at the exchange rate.
    Senator Coburn. One final, and you do not have to answer 
this, but if you would give me your thoughts. A recent paper, 
``Crunch Time: Fiscal Crises and the Role of Monetary Policy,'' 
would you mind at some point in time giving me your thoughts on 
that? I think you have seen that.
    Mr. Bernanke. I will, but I think the main thing I would 
say is that--and I want to be very clear--the CBO agrees that 
the Federal Reserve's balance sheet policies are with very high 
probability going to be a very significant boom to the taxpayer 
in terms of returns to the Treasury.
    Chairman Johnson. Senator Merkley.
    Senator Merkley. Thank you, Mr. Chair, and thank you for 
your testimony.
    I wanted to start with too big to jail. We had the 
situation with Hong Kong-Shanghai Bank Corporation, HSBC, where 
the United States decided not only not to investigate any 
individual, but not to investigate the bank as a whole, related 
to money laundering or related to terrorist organizations and 
drug organizations. It is no small thing, no small thing. Drug 
organizations in Northern Mexico are responsible for 40,000 
deaths. Terrorist organizations, obviously, are a threat to the 
United States. And the too big to jail echoes the fact that we 
still have banks that are so large that we are concerned about 
creating any ripples. In this case, it sends a message, as 
well, about future behavior. If current behavior, be it 
manipulation of the LIBOR rate, which have had fines associated 
with it but not criminal prosecutions, I do not believe, or too 
big to jail for money laundering, does this not kind of 
undermine in a way our international regulatory structure for 
financial institutions?
    Mr. Bernanke. Well, I agree that no individual and no 
institution should be exempt from paying for crimes that they 
commit. On this particular case, we worked very closely with 
the Department of Justice. We cooperated in every possible way 
to give them information. In the end, the company paid a $2 
billion fine. If it relates to the bigger issue you are 
thinking of, of too big to fail, we also agree that that is 
something that really needs to be addressed and that many of 
the parts of Dodd-Frank are intended to address that and we are 
pushing those as hard as we can.
    Senator Merkley. Thank you. And I think it does certainly 
say to us we are a long ways from getting there if we are that 
concerned about any form of shakiness in these large banks.
    But there is another aspect of this, too, and that it 
continues to tell folks that it is safer to invest, if you 
will, in large banks than, say, community banks. A community 
bank would have been shut down or at least investigated 
thoroughly. And in what I see in the economy in Oregon is often 
it is the community banks that are willing to lend into the 
local economies because they understand it better. They are 
more comfortable with it. They understand they may have 
relationships to know the competency of any individual 
companies and so forth. And is this sort of bias kind of 
counterproductive to our overall health of our economy?
    Mr. Bernanke. Absolutely. It means the playing field is not 
level. It means that there is not market discipline, so there 
is too much risk taking. So getting rid of too big to fail is, 
I think, an incredibly important objective and we are working 
in that direction.
    Senator Merkley. Thank you. I want to turn now to the 
fiscal cliff. We had a drop in GDP in the fourth quarter of 
last year. Do you share the view somehow that that was, in 
part, attributable to the December 31 fiscal cliff?
    Mr. Bernanke. Only incidentally. One of the factors that 
happened to contribute to the fourth quarter was a 22 percent 
annual rate drop in defense spending, and it is possible that 
in anticipation of the sequester, for example, there may have 
been some changes in spending patterns. But, as I said in my 
remarks, I think the fourth quarter was really a combination of 
transitory factors. I do not think it really signaled any real 
change in the pace of growth of the economy. On the other hand, 
the pace of growth of the economy remains around 2 percent, 
which is positive, but it is not as strong as we would like.
    Senator Merkley. So now we are looking at the different 
items that you mentioned, the debt ceiling, continuing 
resolution, the sequester, which does convey a feeling of 
lurching from crisis to crisis. We have heard many companies 
have put substantial money aside, that they have not 
reinvested. They have had some very profitable years. Is this 
style that we seem to have adopted, of being unable to get our 
act together and plan a year at a time, if you will, in the 
traditional sense, really kind of shooting ourselves in the 
foot?
    Mr. Bernanke. I think so, Senator. We have not been able to 
identify with accuracy the quantitative impact of uncertainty 
about policy, but we certainly, around the FOMC table, hear 
many anecdotes from businesses about their reluctance to expand 
or hire, given that they are not sure what the fiscal situation 
is going to be.
    Senator Merkley. Switching gears, the Volcker Rule, or 
Volcker firewall between hedge fund -style activities and banks 
that take deposits and make loans, still has not--the 
rulemaking has not been completed. We are well past the 2-year 
mark headed toward 3 years. Does this need to get done so that 
institutions know what the appropriate boundaries are and also 
so that here, we can demonstrate that we actually have the 
ability to pass laws and the rules that go with them and 
operate as a competent society?
    Mr. Bernanke. We would like to get it done and we have made 
a lot of progress on it. The issue at this point is that there 
really--the Volcker Rule is really three or four different 
rules. The CFTC, the SEC, and the banking agencies each has a 
Volcker Rule which applies to the institutions that they 
supervise and there is a strong sense that we have that we 
would be much better served if those rules were closely 
coordinated and as close to being identical as possible. So I 
think the issues at this point are not the work that we have 
done at the Federal Reserve, for example, the issues are 
finding agreement and closure among the different agencies who 
are working on the rule.
    Senator Merkley. Thank you.
    Chairman Johnson. Senator Heller.
    Senator Heller. Thank you, Mr. Chairman, and Mr. Chairman, 
thank you for being here today. I have not had a chance to 
raise some questions since 2008 on the Financial Services 
Committee on the other side, so it is good to have you in front 
of me and thanks for taking time.
    Mr. Bernanke. Sure.
    Senator Heller. You know, we ask a lot of questions a lot 
of different ways, and I am probably not going to be any 
different, but let us give it a shot.
    You know, we have not passed a budget around here in 4 
years. Are you optimistic that sometime in your lifetime we may 
pass another budget around here in Washington, DC? For that 
matter, let me ask you another question, and you can answer 
them together. Do you think we will ever balance a budget, have 
a balanced budget in your lifetime?
    Mr. Bernanke. Well, I would settle for stabilization of the 
ratio of debt-to-GDP, which is a slightly less tough level.
    Senator Heller. It sounds like a ``no.''
    Mr. Bernanke. I have--you know, it is easy to criticize, 
but the politics is very difficult. I understand that there are 
a lot of very different views and strongly held views and it is 
not easy to come to an agreement. So I do not think Congress is 
not trying. I know you are trying, and I hope that you can find 
the agreement to see these important objectives.
    Senator Heller. Well, the reason I raise the question, I 
think the sequestration issue that we have in front of us on 
Friday is a result of our lack of budgeting and effort to 
budget. I am from Nevada, so if I am putting money down, I am 
putting $100 down that sequestration comes and goes on Friday. 
Then as soon as that occurs, we get into our Budget Committee 
markups that are supposed to happen on March 11 through the 
15th. I am putting another $100 down that that does not happen.
    Then we are supposed to bring those bills down to the floor 
sometime on March 18, and then March 27, Government funding 
expires because we do not budget, and I am arguing that that 
day comes and goes and we have a big argument. All I am talking 
about is the instability that we have and how difficult does 
that make your job?
    Mr. Bernanke. Well, it makes my job difficult, but it also 
makes the economy's job difficult. Again, as Senator Merkley 
mentioned, the uncertainty associated with not knowing how 
policy is going to be developed and what tax rates will be and 
what spending will be and what programs will be and which 
contractors will be receiving funding, et cetera, those are 
important concerns.
    Senator Heller. And I know your policies are based on 
monetary policy and also unemployment and employment, and I 
have to believe that our indecisiveness and inability to get 
things done is causing a lot of consternation.
    You made a comment, and you have actually repeated this in 
this hearing, that you will continue--I want to go to 
quantitative easing, that is your purchasing of these assets--
will continue until substantial improvements in the outlook of 
the labor market in the context of price stability. Will you 
explain to me a little bit more in depth what that means?
    Mr. Bernanke. Well, sure. We are going to be looking at a 
variety of variables. We will be looking at payroll employment, 
is it strengthening, is it sustainably strengthening? Is the 
unemployment rate coming down? So those are indications----
    Senator Heller. Do you have a target?
    Mr. Bernanke. We do not have a specific target. We have 
given thresholds for our rate policy. We have not extended 
those to our asset purchases, and there are a couple of 
reasons. One is, as you mentioned, there are a lot of other 
things happening in our economy, like the fiscal issues that 
you referred to. But in addition, we are paying very close 
attention, as a number of you have mentioned, to the efficacy 
and cost of these policies and that makes it very difficult to 
say this is the number we are going to achieve.
    So we are doing our best to communicate the criteria for 
action, but we have not been able to come to a specific number 
which encapsulates both the change in outlook for the labor 
market and the assessment of costs and efficacy, which is 
another part of the decision process.
    Senator Heller. Do you believe that your asset purchases 
are causing any kind of an equity bubble?
    Mr. Bernanke. I do not see much evidence of an equity 
bubble. Earnings are very high. As I said, the equity risk 
premium is above normal. That is, in other words, equity 
holders are still being somewhat risk averse in their behavior.
    But again, we have a two-part plan. First is to monitor 
these different asset markets. The second is to try to 
understand what would be the implications if we are wrong. What 
would happen? Who would be hurt? What would happen to financial 
institutions? Would there be broad knock-on effects if, in 
fact, some particular asset turned out to be in a bubble? So we 
are trying to do both of those things and we do not rule out 
that if these problems become sufficiently worrisome, that they 
would be taken into account in our monetary policy.
    Senator Heller. Mr. Chairman, thank you.
    Mr. Chairman, thank you.
    Chairman Johnson. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman, and I also want to 
say thank you, Mr. Chairman. This has been my first chance to 
say in public how grateful I am for your help in setting up the 
consumer agency and how helpful all the people were at the Fed 
during the time of transition of the consumer function, so 
thank you very much.
    I would like to go to the question about too big to fail, 
that we have not gotten rid of it yet, and so now we have a 
double problem and that is that the big banks, big at the time 
that they were bailed out the first time, have gotten bigger, 
and at the same time that investors believe with too big to 
fail out there that it is safer to put your money into the big 
banks and not the little banks, in effect creating an insurance 
policy for the big banks, that the Government is creating this 
insurance policy not there for the small banks.
    And now some economists, including an economist at the IMF, 
have started to document exactly how much that subsidy is 
worth. Last week, Bloomberg did the math on it and came up with 
the number $83 billion that the big banks get in what is 
essentially a free insurance policy. They borrow cheaper than 
the small banks do.
    So I understand that we are all trying to get to the end of 
too big to fail, but my question, Mr. Chairman, is, until we 
do, should those biggest financial institutions be repaying the 
American taxpayer that $83 billion subsidy that they are 
getting?
    Mr. Bernanke. Well, the subsidy is coming because of market 
expectations that the Government would bail out these firms if 
they failed. Those expectations are incorrect. We have an 
orderly liquidation authority. And even in the crisis, in the 
cases of AIG, for example, we wiped out the shareholders----
    Senator Warren. Excuse me, Mr. Chairman. You did not wipe 
out the shareholders of the largest financial institutions, did 
you, the big banks?
    Mr. Bernanke. Because we did not have the tools. Now, we 
could.
    Senator Warren. Well, but the----
    Mr. Bernanke. Now we have the tools.
    Senator Warner. Eighty-three billion dollars says that 
whatever you are saying, Mr. Chairman, $83 billion says that 
there really will be a bailout for the largest financial 
institutions if they fail.
    Mr. Bernanke. No, that is the expectation of markets, but 
that does not mean that we have to do it. I think what we have 
to do is solve the problem, Senator. I think we are really in 
agreement on this. Too big to fail is not absolute. There are 
spreads. The credit default swaps say there is some probability 
of failure. Moody's and others have downgraded these firms. 
They have taken down some of their Government support ratings, 
as you know. But we have a lot more to do, I agree, and I think 
that is a good debate to have, but we are in complete agreement 
that we need to stop too big to fail.
    Senator Warren. But I do not understand. It is working like 
an insurance policy. Ordinary folks pay for homeowners' 
insurance. Ordinary folks pay for car insurance. And these big 
financial institutions are getting cheaper borrowing to the 
tune of $83 billion in a single year simply because people 
believe that the Government would step in and bail them out. 
And I am just saying, if they are getting it, why should they 
not pay for it?
    Mr. Bernanke. I think we should get rid of it.
    Senator Warren. Well, all right, then I will ask the other 
question. You were here in July and you said that you were--you 
commended Dodd-Frank for providing a blueprint to get rid of 
too big to fail. We have now understood this problem for nearly 
5 years. So when are we going to get rid of too big to fail?
    Mr. Bernanke. Well, as we have been discussing, some of 
these rules take time to develop. The orderly liquidation 
authority, I think we made a lot of progress on that. We have 
got the living wills. I think we are moving in the right 
direction. If additional steps are needed, then Congress 
obviously can discuss those. But we do have a plan and I think 
it is moving in the right direction.
    Senator Warren. Any idea about when we are going to arrive 
in the right direction?
    Mr. Bernanke. It is not a zero, one kind of thing. It is 
over time you will see increasing market expectations that 
these institutions can fail. And I would make another 
prediction, and predictions are always dangerous, that the 
benefits of being large are going to decline over time, which 
means that some banks are going to voluntarily begin to reduce 
their size because they are not getting the benefit that they 
used to get.
    Senator Warren. I read you on this. I read your predictions 
on this in your earlier testimony. But so far, it looks like 
they are getting $83 billion for staying big.
    Mr. Bernanke. Well, that is one study, Senator. You do not 
know whether that is an accurate number or----
    Senator Warren. Well, OK. We will go back and look at it 
again if you think there is a problem with it. But does it 
worry you?
    Mr. Bernanke. Of course. I think this is very important, 
and we are putting a lot of effort into this. It is a problem 
that we have had for a very long time and I do not think we can 
solve it immediately, but I assure that, as somebody who has 
spent a lot of late nights trying to deal with these problems 
and the crisis, I would very much like to have the confidence 
that we could close down a large institution without causing 
damage to the rest of the economy.
    Senator Warren. Fair enough. I know we are both trying to 
go in the same direction. I am just pointing out that in all 
that space in between, what is happening is the big banks are 
getting a terrific break and the little banks are just getting 
smashed on this. They are not getting that kind of break, and 
that has long-term impact for all of the financial system.
    Mr. Bernanke. I agree with you 100 percent.
    Senator Warren. Thank you.
    Chairman Johnson. Senator Vitter.
    Senator Vitter. Thank you, Mr. Chairman, and thank you, Mr. 
Chairman, for being here.
    My top concern is actually exactly the same as Ms. 
Warren's, and I think that is a statement in and of itself that 
there is growing bipartisan concern across the whole political 
spectrum about the fact--I believe it is a fact--that too big 
to fail is alive and well.
    First of all, in terms of the study, Ms. Warren cited the 
Bloomberg calculations, but that is clearly not the only thing 
out there. There is an FDIC study released in September that 
concludes that, quote, ``The largest banks do, in fact, pay 
less for comparable deposits. Furthermore, we show that some of 
the difference in the cost of funding cannot be attributed to 
either differences in balance sheet risk or any non- risk-
related factors. The remaining unexplained risk premium gap is 
on the order of 45 basis points. Such a gap is consistent with 
an economically significant too big to fail subsidy paid to the 
largest banks,'' close quote.
    In addition, an IMF working paper has attempted to quantify 
this subsidy and it said the subsidy, quote, ``was already 
sizable, 60 basis points, as of the end of 2007, before the 
crisis. It increased to 80 basis points by the end of 2009,'' 
close quote.
    Then we have the Bloomberg quantification which was working 
off that IMF work that was mentioned, and also a Board member, 
Daniel Tarullo, who says, quote, ``To the extent that a growing 
systemic footprint increases perceptions of at least some 
residual too big to fail quality in such a firm, 
notwithstanding the panoply of measures in Dodd-Frank and our 
regulations, there may be funding advantages for the firm which 
reinforces the impulse to grow,'' close quote.
    So my first point is it is not just one outlier study. 
Given all of that, what specifically is in process in terms of 
regulations or should be put in process to counteract that, 
because my concern is even if this problem is solved 2 years 
from now, the entire landscape of American banking will be 
different by then, including a lot of solid smaller firms gone, 
and I think that is a real loss to our financial system.
    Mr. Bernanke. There is a three-part plan under Dodd-Frank. 
Part number one is to impose costs on large institutions that 
offset the benefits they get in the funding markets, for 
example, capital surcharges, activity restrictions, liquidity 
requirements, living wills, a whole bunch of other things that 
impose greater cost and force the largest firms to take into 
account their systemic footprint. That is number one.
    Number two is the orderly liquidation authority, which we 
are working closely with the FDIC and with our foreign 
counterparts to figure out how we would take down a large 
institution without bringing down the system.
    And part three is a whole raft of measures to try to 
strengthen the overall financial system so that it would be 
more credible that we could take down a large institution 
without bringing down the system.
    That is sort of the three-part plan. It is working to some 
extent. For example, even though U.S. banks are stronger 
financially than European banks. Frequently, U.S. banks have 
wider credit default swap spreads, indicating a higher 
probability of actual failure, because the differences between 
U.S. and Europe in terms of Government--perceived Government 
support. So that is the process. That is the plan.
    There have been additional ideas, such as, essentially 
reinstating Glass-Steagall, separating the commercial banking 
and investment banking activities. We are doing that to some 
extent, for example, with the Volcker Rule, but I do not think 
that Glass-Steagall by itself really would be all that helpful 
because, after all, in the crisis, some of the firms that 
failed were straight investment banks and some of the firms 
that were in trouble were straight commercial banks.
    So I am open to discussing additional measures, but the 
plan is to impose costs on the largest banks to make them 
internalize their systemic imprint, to develop a liquidation 
authority, and to strengthen the overall system. And over time, 
that ought to improve the situation, but if it does not, I 
think we ought to consider alternative and additional steps.
    Senator Vitter. Well, in closing, I would really continue 
to encourage you all doing that now. And again, I think this is 
a bipartisan concern. I have expressed this concern and several 
ideas, for instance, with Senator Brown on the Committee.
    The three components you described are understood by the 
market. In my opinion, they have been digested and valued by 
the market and the market still says there is too big to fail. 
In particular, I would continue to urge you to revisit higher 
capital requirements beyond the marginally higher requirements 
that you have instituted so far for megabanks and I would 
continue to urge you all to think of alternatives to Basel III, 
as well, in the same spirit. Thank you.
    Mr. Bernanke. Thank you, Senator.
    Chairman Johnson. Senator Manchin.
    Senator Manchin. Mr. Chairman, thank you.
    Chairman Bernanke, thank you for being here.
    First of all, when I first came to the Senate 2\1/2\ years 
ago, I was in the Armed Services Committee and Admiral Mullins 
at that time was asked, what is the greatest threat the United 
States faces, and I thought I would hear some military 
challenge. And he did not even hesitate by saying that the debt 
of this Nation is our greatest threat, and I did not know if 
you shared that same thought.
    Mr. Bernanke. It is certainly an important economic risk 
and I think it is very important that, over the longer term, 
that we develop a sustainable fiscal plan, no question about 
it.
    Senator Manchin. I mean, his assessment was it was the 
greatest threat we faced.
    Mr. Bernanke. I do not know. There are many possible 
candidates for that.
    Senator Manchin. Also, I know they talked a lot about 
sequestering today, and we were talking back and forth the 
consequences if we do and if we do not. The bottom line, 
sequestering came into being because in 2011, the summer of 
2011, we thought we put a supercommittee together that had a 
goal of $1.5 trillion. If they did not reach that goal, they 
had a minimum penalty of $1.2 trillion across the board in 
defense and nondefense. We voted on that as a body. Now, we are 
looking for every way to get out of that, saying it was too 
draconian. We should never have done it.
    But we did it. And what we were saying is if we do not do 
it at all and negate that responsibility and promise of a vote 
that we made for the public, what effect would that have on the 
market? I know I have heard everything about the effects that 
it would have if we do it. What effects would it have on the 
market if we do not do it?
    Mr. Bernanke. Well, my recommendation, and, of course, I 
can only recommend to you----
    Senator Manchin. Sure. I agree.
    Mr. Bernanke. ----it is obviously Congress's decision how 
to proceed--is a two-part recommendation. Look at both the 
short run and the long run. I think it is true that just 
canceling the sequester would not solve the overall problem----
    Senator Manchin. No----
    Mr. Bernanke. ----which is the long-term fiscal issue. So 
if you cut the sequester or delay it, however you modify it----
    Senator Manchin. Right.
    Mr. Bernanke. ----you ought to compensate for that with, in 
my recommendation, by looking at measures that address the 
longer-term fiscal concerns, which is what the CBO shows to be 
the point where the debt really begins to explode. And that is 
the trade-off I would suggest.
    Senator Manchin. It would be irresponsible for us not to do 
something. We have two alternatives, two paths to take here. 
Either fix the financial problems in a longer-term, bigger fix, 
or do something with sequestering that we punished ourself 
basically because we have been unable as a body to come 
together. So I think that was also said. If we are going to do 
a sequestering, should it not be done in a more or smarter way 
to where there is more flexibility?
    Mr. Bernanke. Well, as you point out, it was done to be 
sort of like Dr. Strangelove----
    Senator Manchin. Right. Right.
    Mr. Bernanke. ----you know, the bomb that goes off. So 
obviously, if you can find a way to, in a bipartisan way, to 
make it more effective and better prioritized, that would be a 
good thing.
    Senator Manchin. OK.
    Mr. Bernanke. And people disagree on the second point, but 
again, what I suggested today is trying to make some tradeoff 
between the effects on the near-term recovery and aligning the 
policy with the timing. The timing says that you have made 
progress in the very near term as far as the budget is 
concerned. Where the problem still remains unaddressed is in 
the longer term. And so it does not quite match to be doing 
tough policies today when the real problem is a somewhat 
longer-term problem.
    Senator Manchin. Sure.
    Mr. Bernanke. That is what I am trying to suggest.
    Senator Manchin. Well, I am just saying that there are a 
lot of us concerned about we keep kicking the can down the 
road, but that is a whole another conversation.
    My final question would be, sir, how big is our national 
debt?
    Mr. Bernanke. Well, there are a lot of different measures 
of it. The----
    Senator Manchin. What would be your explanation of it?
    Mr. Bernanke. Well, the basic measure, which is the debt 
held by the public, which includes the debt held by the Fed, it 
is about $11 trillion----
    Senator Manchin. Right.
    Mr. Bernanke. ----about 75 or 73 percent of GDP.
    Senator Manchin. Correct.
    Mr. Bernanke. That does not include, though, for example, 
so-called unfunded liabilities, such as the promises that have 
been made to future Medicare recipients, for example----
    Senator Manchin. Well, the average person would understand 
that they have a responsibility and their ability to pay back 
in good faith. So how much of what is our total national debt 
that is responsible by the good faith of this country and the 
people in this country?
    Mr. Bernanke. It is currently about $11 trillion.
    Senator Manchin. OK, but if you had everything when you--
our gross Federal debt?
    Mr. Bernanke. Gross Federal debt includes debt owed by 
parts of the Government to other parts of the Government, like 
the Social Security Trust Fund, for example----
    Senator Manchin. Responsibilities of Fannie and Freddie?
    Mr. Bernanke. So that is another element. That is 
guarantees. That is not direct debt. That is a potential 
liability. So it is complicated.
    Senator Manchin. Yes.
    Mr. Bernanke. As I said at the beginning, it is hard to----
    Senator Manchin. If you looked at all of the----
    Mr. Bernanke. ----get a single number.
    Senator Manchin. ----the worst case scenario, the faith and 
full credit of this country, what would you say it would be?
    Mr. Bernanke. Well, I saw the article I think you are 
referring to and it included the possibility that----
    Senator Manchin. Is it accurate?
    Mr. Bernanke. It included the possibility that the 
Government would have to pay off every deposit in the United 
States through the FDIC----
    Senator Manchin. Yes.
    Mr. Bernanke. ----which is not a realistic possibility. 
There are some alternative measures which are certainly bigger 
than $11 trillion----
    Senator Manchin. I think they were saying----
    Mr. Bernanke. ----but I do not have those numbers----
    Senator Manchin. They said as much as $30 trillion it could 
be, total exposure.
    Mr. Bernanke. If you include all of the Medicare and----
    Senator Manchin. But it is definitely higher than $16 
trillion.
    Mr. Bernanke. Yes, I would say that is fair.
    Senator Manchin. Thank you.
    Chairman Johnson. There is a vote pending, but does the 
Senator from Tennessee care to make a brief----
    Senator Corker. Just one very quick question, and I was 
interested--I went back to the office and did not expect to 
come back, but listening to the exchange with Senator Warren 
and Senator Vitter, it reminded me of--the questioning was 
Tarullo, who was in last, who you served with on the Fed Board, 
and just--he had mentioned--I asked him about systemic risk, 
and I know that the Fed is obviously a member of the FSOC and 
your goal is to identify systemic risk and deal with that. And 
that was much like the answer that you gave to Senator Warren a 
minute ago. It is kind of, we are on this journey.
    But I would ask the question. Is there any entity in our 
country that if it failed would create systemic risk, and if 
so, why is that still the case after the creation of Dodd-
Frank? I mean, why have we not moved more quickly? Why are we 
taking so long on this journey? And is there an institution 
that if it failed would pose systemic risk to our country? And 
if so, would you identify it?
    Mr. Bernanke. The only answer I can give you is that Dodd-
Frank is a complicated bill. Many of the rules are not----
    Senator Corker. But that piece of it is not very 
complicated. It is only about eight words, and so that is not 
complicated. It is a directive to you, and you are a big part 
of this and you came out a big winner in Dodd-Frank. And I 
guess I would just ask the question, why would you not go ahead 
and identify that, and if there is an entity that is in our 
Nation, if it failed, something that poses systemic risk, you 
would know that. Why do we not go ahead and move to deal with 
that?
    Mr. Bernanke. Well, the FSOC actually has the authority to 
designate nonbank firms that it views as systemic and they come 
under the oversight of the Fed.
    Senator Corker. Well, let me ask you, if we have firms, 
though, are we going to--is it your thought that under this 
power that you have been given, is it your thought that we 
could continue to have firms operating in our country that if 
they failed, they would pose systemic risk, or are we going to 
try to mitigate that in some other way? I would just be 
curious.
    Mr. Bernanke. The goal of the powers that you gave to the 
Fed and other agencies is to, as much as possible, eliminate 
that problem over time. Additional steps, I think, would 
require Congressional action beyond what we have implemented.
    Senator Corker. I do not think so. I am going to follow up 
with a letter. I thank you for your testimony----
    Mr. Bernanke. Sure.
    Senator Corker. And I do not think that is the case.
    Chairman Johnson. Thank you again, Chairman Bernanke, for 
your testimony and for being here with us today.
    This hearing is adjourned.
    [Whereupon, at 12:10 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
               PREPARED STATEMENT OF CHAIRMAN TIM JOHNSON
    The Committee will come to order.
    Today's hearing is with Chairman Bernanke on the Federal Reserve's 
Monetary Policy Report to Congress. While progress toward maximum 
employment has been slow, it has been positive and steady thanks in 
part to the Fed's thoughtful and well-measured monetary actions. Our 
economy has added private sector jobs for 35 straight months. During 
that time, over 6 million new jobs have been created, but we should not 
sacrifice those gains by slamming on the brakes now.
    Without a fix, automatic spending cuts will take effect in just a 
few days, and could send our economy into reverse at a time we should 
continue moving forward on creating jobs. Projections suggest the 
sequester will cost us 750,000 jobs this year. In addition to layoffs 
for cops, fire fighters, and teachers that could devastate our 
communities, these cuts will impact many of our Nation's most 
vulnerable citizens including children, seniors, and the disabled. At a 
time when the U.S. faces an array of national security threats, the 
sequester will affect our military readiness.
    It is unacceptable that we are lurching from one manufactured 
crisis to the next, and Americans have had enough. These fights are bad 
for the economy and are making it harder for families to make ends 
meet.
    The steep drops in consumer confidence during the fights over the 
debt limit and the fiscal cliff rival the fallout after Lehman 
Brothers' failure and 9/11. This has consequences. If consumers do not 
spend, businesses will not prosper and hire more workers. If businesses 
are not hiring, our economy will not grow. It is that simple.
    We must do all we can to restore confidence in not only our 
financial system, but also in our ability as a country to tackle long-
term challenges in a responsible, bipartisan manner. In addition to 
Congress acting on a deficit reduction plan that is balanced and 
promotes job creation, there are things this Committee can do to help 
achieve these goals. From rigorous oversight, to confirming well-
qualified nominees, to reauthorizing expiring laws, to reaching 
consensus on the future of housing finance, there are steps this 
Committee can take to promote consumer confidence, provide businesses 
clarity to move forward with long-term plans, and strengthen our 
economic recovery.
    Chairman Bernanke, I look forward to hearing your views as both the 
Fed and the Congress pursue policies supporting our Nation's economic 
recovery.
                                 ______
                                 
                 PREPARED STATEMENT OF BEN S. BERNANKE
       Chairman, Board of Governors of the Federal Reserve System
                           February 26, 2013

    Chairman Johnson, Ranking Member Crapo, and other Members of the 
Committee, I am pleased to present the Federal Reserve's Semiannual 
Monetary Policy Report. I will begin with a short summary of current 
economic conditions and then discuss aspects of monetary and fiscal 
policy.

Current Economic Conditions
    Since I last reported to this Committee in mid-2012, economic 
activity in the United States has continued to expand at a moderate if 
somewhat uneven pace. In particular, real gross domestic product (GDP) 
is estimated to have risen at an annual rate of about 3 percent in the 
third quarter but to have been essentially flat in the fourth quarter. 
\1\ The pause in real GDP growth last quarter does not appear to 
reflect a stalling-out of the recovery. Rather, economic activity was 
temporarily restrained by weather-related disruptions and by transitory 
declines in a few volatile categories of spending, even as demand by 
U.S. households and businesses continued to expand. Available 
information suggests that economic growth has picked up again this 
year.
---------------------------------------------------------------------------
     \1\ Data for the fourth quarter of 2012 from the national income 
and product accounts reflect the advance estimate released on January 
30, 2013.
---------------------------------------------------------------------------
    Consistent with the moderate pace of economic growth, conditions in 
the labor market have been improving gradually. Since July, nonfarm 
payroll employment has increased by 175,000 jobs per month on average, 
and the unemployment rate declined 0.3 percentage point to 7.9 percent 
over the same period. Cumulatively, private-sector payrolls have now 
grown by about 6.1 million jobs since their low point in early 2010, 
and the unemployment rate has fallen a bit more than 2 percentage 
points since its cyclical peak in late 2009. Despite these gains, 
however, the job market remains generally weak, with the unemployment 
rate well above its longer-run normal level. About 4.7 million of the 
unemployed have been without a job for 6 months or more, and millions 
more would like full-time employment but are able to find only part-
time work. High unemployment has substantial costs, including not only 
the hardship faced by the unemployed and their families, but also the 
harm done to the vitality and productive potential of our economy as a 
whole. Lengthy periods of unemployment and underemployment can erode 
workers' skills and attachment to the labor force or prevent young 
people from gaining skills and experience in the first place--
developments that could significantly reduce their productivity and 
earnings in the longer term. The loss of output and earnings associated 
with high unemployment also reduces Government revenues and increases 
spending, thereby leading to larger deficits and higher levels of debt.
    The recent increase in gasoline prices, which reflects both higher 
crude oil prices and wider refining margins, is hitting family budgets. 
However, overall inflation remains low. Over the second half of 2012, 
the price index for personal consumption expenditures rose at an annual 
rate of 1\1/2\ percent, similar to the rate of increase in the first 
half of the year. Measures of longer-term inflation expectations have 
remained in the narrow ranges seen over the past several years. Against 
this backdrop, the Federal Open Market Committee (FOMC) anticipates 
that inflation over the medium term likely will run at or below its 2 
percent objective.

Monetary Policy
    With unemployment well above normal levels and inflation subdued, 
progress toward the Federal Reserve's mandated objectives of maximum 
employment and price stability has required a highly accommodative 
monetary policy. Under normal circumstances, policy accommodation would 
be provided through reductions in the FOMC's target for the Federal 
funds rate--the interest rate on overnight loans between banks. 
However, as this rate has been close to zero since December 2008, the 
Federal Reserve has had to use alternative policy tools.
    These alternative tools have fallen into two categories. The first 
is ``forward guidance'' regarding the FOMC's anticipated path for the 
Federal funds rate. Since longer-term interest rates reflect market 
expectations for shorter-term rates over time, our guidance influences 
longer-term rates and thus supports a stronger recovery. The 
formulation of this guidance has evolved over time. Between August 2011 
and December 2012, the Committee used calendar dates to indicate how 
long it expected economic conditions to warrant exceptionally low 
levels for the Federal funds rate. At its December 2012 meeting, the 
FOMC agreed to shift to providing more explicit guidance on how it 
expects the policy rate to respond to economic developments. 
Specifically, the December postmeeting statement indicated that the 
current exceptionally low range for the Federal funds rate ``will be 
appropriate at least as long as the unemployment rate remains above 
6\1/2\ percent, inflation between 1 and 2 years ahead is projected to 
be no more than a half percentage point above the Committee's 2 percent 
longer-run goal, and longer-term inflation expectations continue to be 
well anchored.'' \2\ An advantage of the new formulation, relative to 
the previous date-based guidance, is that it allows market participants 
and the public to update their monetary policy expectations more 
accurately in response to new information about the economic outlook. 
The new guidance also serves to underscore the Committee's intention to 
maintain accommodation as long as needed to promote a stronger economic 
recovery with stable prices. \3\
---------------------------------------------------------------------------
     \2\ See, Board of Governors of the Federal Reserve System (2012), 
``Federal Reserve Issues FOMC Statement'', press release, December 12, 
www.federalreserve.gov/newsevents/press/monetary/20121212a.htm.
     \3\ The numerical values for unemployment and inflation included 
in the guidance are thresholds, not triggers; that is, depending on 
economic circumstances at the time, the Committee may judge that it is 
not appropriate to begin raising its target for the Federal funds rate 
as soon as one or both of the thresholds is reached. The 6\1/2\ percent 
threshold for the unemployment rate should not be interpreted as the 
Committee's longer-term objective for unemployment; because monetary 
policy affects the economy with a lag, the first increase in the target 
for the funds rate will likely have to occur when the unemployment rate 
is still above its longer-run normal level. Likewise, the Committee has 
not altered its longer-run goal for inflation of 2 percent, and it 
neither seeks nor expects a persistent increase in inflation above that 
target.
---------------------------------------------------------------------------
    The second type of nontraditional policy tool employed by the FOMC 
is large-scale purchases of longer-term securities, which, like our 
forward guidance, are intended to support economic growth by putting 
downward pressure on longer-term interest rates. The Federal Reserve 
has engaged in several rounds of such purchases since late 2008. Last 
September the FOMC announced that it would purchase agency mortgage-
backed securities at a pace of $40 billion per month, and in December 
the Committee stated that, in addition, beginning in January it would 
purchase longer-term Treasury securities at an initial pace of $45 
billion per month. \4\ These additional purchases of longer-term 
Treasury securities replace the purchases we were conducting under our 
now-completed maturity extension program, which lengthened the maturity 
of our securities portfolio without increasing its size. The FOMC has 
indicated that it will continue purchases until it observes a 
substantial improvement in the outlook for the labor market in a 
context of price stability.
---------------------------------------------------------------------------
     \4\ See, Board of Governors of the Federal Reserve System (2012), 
``Federal Reserve Issues FOMC Statement'', press release, September 13, 
www.federalreserve.gov/newsevents/press/monetary/20120913a.htm; and 
Board of Governors, ``FOMC Statement'', December 12, in n. 2.
---------------------------------------------------------------------------
    The Committee also stated that in determining the size, pace, and 
composition of its asset purchases, it will take appropriate account of 
their likely efficacy and costs. In other words, as with all of its 
policy decisions, the Committee continues to assess its program of 
asset purchases within a cost-benefit framework. In the current 
economic environment, the benefits of asset purchases, and of policy 
accommodation more generally, are clear: Monetary policy is providing 
important support to the recovery while keeping inflation close to the 
FOMC's 2 percent objective. Notably, keeping longer-term interest rates 
low has helped spark recovery in the housing market and led to 
increased sales and production of automobiles and other durable goods. 
By raising employment and household wealth--for example, through higher 
home prices--these developments have in turn supported consumer 
sentiment and spending.
    Highly accommodative monetary policy also has several potential 
costs and risks, which the Committee is monitoring closely. For 
example, if further expansion of the Federal Reserve's balance sheet 
were to undermine public confidence in our ability to exit smoothly 
from our accommodative policies at the appropriate time, inflation 
expectations could rise, putting the FOMC's price-stability objective 
at risk. However, the Committee remains confident that it has the tools 
necessary to tighten monetary policy when the time comes to do so. As I 
noted, inflation is currently subdued, and inflation expectations 
appear well anchored; neither the FOMC nor private forecasters are 
projecting the development of significant inflation pressures.
    Another potential cost that the Committee takes very seriously is 
the possibility that very low interest rates, if maintained for a 
considerable time, could impair financial stability. For example, 
portfolio managers dissatisfied with low returns may ``reach for 
yield'' by taking on more credit risk, duration risk, or leverage. On 
the other hand, some risk-taking--such as when an entrepreneur takes 
out a loan to start a new business or an existing firm expands 
capacity--is a necessary element of a healthy economic recovery. 
Moreover, although accommodative monetary policies may increase certain 
types of risk-taking, in the present circumstances they also serve in 
some ways to reduce risk in the system, most importantly by 
strengthening the overall economy, but also by encouraging firms to 
rely more on longer-term funding, and by reducing debt service costs 
for households and businesses. In any case, the Federal Reserve is 
responding actively to financial stability concerns through 
substantially expanded monitoring of emerging risks in the financial 
system, an approach to the supervision of financial firms that takes a 
more systemic perspective, and the ongoing implementation of reforms to 
make the financial system more transparent and resilient. Although a 
long period of low rates could encourage excessive risk-taking, and 
continued close attention to such developments is certainly warranted, 
to this point we do not see the potential costs of the increased risk-
taking in some financial markets as outweighing the benefits of 
promoting a stronger economic recovery and more-rapid job creation. \5\
---------------------------------------------------------------------------
     \5\ The Federal Reserve is also monitoring financial markets to 
ensure that asset purchases do not impair their functioning.
---------------------------------------------------------------------------
    Another aspect of the Federal Reserve's policies that has been 
discussed is their implications for the Federal budget. The Federal 
Reserve earns substantial interest on the assets it holds in its 
portfolio, and, other than the amount needed to fund our cost of 
operations, all net income is remitted to the Treasury. With the 
expansion of the Federal Reserve's balance sheet, yearly remittances 
have roughly tripled in recent years, with payments to the Treasury 
totaling approximately $290 billion between 2009 and 2012. \6\ However, 
if the economy continues to strengthen, as we anticipate, and policy 
accommodation is accordingly reduced, these remittances would likely 
decline in coming years. Federal Reserve analysis shows that 
remittances to the Treasury could be quite low for a time in some 
scenarios, particularly if interest rates were to rise quickly. \7\ 
However, even in such scenarios, it is highly likely that average 
annual remittances over the period affected by the Federal Reserve's 
purchases will remain higher than the precrisis norm, perhaps 
substantially so. Moreover, to the extent that monetary policy promotes 
growth and job creation, the resulting reduction in the Federal deficit 
would dwarf any variation in the Federal Reserve's remittances to the 
Treasury.
---------------------------------------------------------------------------
     \6\ See, Board of Governors of the Federal Reserve System (2013), 
``Reserve Bank Income and Expense Data and Transfers to the Treasury 
for 2012'', press release, January 10, www.federalreserve.gov/
newsevents/press/other/20130110a.htm.
     \7\ See, Carpenter, Seth B., Jane E. Ihrig, Elizabeth C. Klee, 
Daniel W. Quinn, and Alexander H. Boote (2013), ``The Federal Reserve's 
Balance Sheet and Earnings: A Primer and Projections'', Finance and 
Economics Discussion Series 2013-01 (Washington: Federal Reserve Board, 
January), available at http://www.federalreserve.gov/pubs/feds/2013/
201301/201301pap.pdf.
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Thoughts on Fiscal Policy
    Although monetary policy is working to promote a more robust 
recovery, it cannot carry the entire burden of ensuring a speedier 
return to economic health. The economy's performance both over the near 
term and in the longer run will depend importantly on the course of 
fiscal policy. The challenge for the Congress and the Administration is 
to put the Federal budget on a sustainable long-run path that promotes 
economic growth and stability without unnecessarily impeding the 
current recovery.
    Significant progress has been made recently toward reducing the 
Federal budget deficit over the next few years. The projections 
released earlier this month by the Congressional Budget Office (CBO) 
indicate that, under current law, the Federal deficit will narrow from 
7 percent of GDP last year to 2\1/2\ percent in fiscal year 2015. \8\ 
As a result, the Federal debt held by the public (including that held 
by the Federal Reserve) is projected to remain roughly 75 percent of 
GDP through much of the current decade.
---------------------------------------------------------------------------
     \8\ See, Congressional Budget Office (2013), ``The Budget and 
Economic Outlook: Fiscal Years 2013 to 2023'' (Washington: CBO, 
February), available at www.cbo.gov/publication/43907.
---------------------------------------------------------------------------
    However, a substantial portion of the recent progress in lowering 
the deficit has been concentrated in near-term budget changes, which, 
taken together, could create a significant headwind for the economic 
recovery. The CBO estimates that deficit-reduction policies in current 
law will slow the pace of real GDP growth by about 1\1/2\ percentage 
points this year, relative to what it would have been otherwise. A 
significant portion of this effect is related to the automatic spending 
sequestration that is scheduled to begin on March 1, which, according 
to the CBO's estimates, will contribute about 0.6 percentage point to 
the fiscal drag on economic growth this year. Given the still-moderate 
underlying pace of economic growth, this additional near-term burden on 
the recovery is significant. Moreover, besides having adverse effects 
on jobs and incomes, a slower recovery would lead to less actual 
deficit reduction in the short run for any given set of fiscal actions.
    At the same time, and despite progress in reducing near-term budget 
deficits, the difficult process of addressing longer-term fiscal 
imbalances has only begun. Indeed, the CBO projects that the Federal 
deficit and debt as a percentage of GDP will begin rising again in the 
latter part of this decade, reflecting in large part the aging of the 
population and fast-rising health care costs. To promote economic 
growth in the longer term, and to preserve economic and financial 
stability, fiscal policy makers will have to put the Federal budget on 
a sustainable long-run path that first stabilizes the ratio of Federal 
debt to GDP and, given the current elevated level of debt, eventually 
places that ratio on a downward trajectory. Between 1960 and the onset 
of the financial crisis, Federal debt averaged less than 40 percent of 
GDP. This relatively low level of debt provided the Nation much-needed 
flexibility to meet the economic challenges of the past few years. 
Replenishing this fiscal capacity will give future Congresses and 
Administrations greater scope to deal with unforeseen events.
    To address both the near- and longer-term issues, the Congress and 
the Administration should consider replacing the sharp, frontloaded 
spending cuts required by the sequestration with policies that reduce 
the Federal deficit more gradually in the near term but more 
substantially in the longer run. Such an approach could lessen the 
near-term fiscal headwinds facing the recovery while more effectively 
addressing the longer-term imbalances in the Federal budget.
    The sizes of deficits and debt matter, of course, but not all tax 
and spending programs are created equal with respect to their effects 
on the economy. To the greatest extent possible, in their efforts to 
achieve sound public finances, fiscal policy makers should not lose 
sight of the need for Federal tax and spending policies that increase 
incentives to work and save, encourage investments in workforce skills, 
advance private capital formation, promote research and development, 
and provide necessary and productive public infrastructure. Although 
economic growth alone cannot eliminate Federal budget imbalances, in 
either the short or longer term, a more rapidly expanding economic pie 
will ease the difficult choices we face.

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

Q.1. The United Kingdom has had a Financial Transactions Tax 
(FTT), in the form of stamp duty on stock purchases, for more 
than 300 years. It does not seem to have hindered London's 
financial development. And now 11 European countries are about 
to impose a new FTT of 10 basis points on trading. They say it 
will discourage certain kinds of quick in-and-out transactions 
that benefit traders but not investors--and pull in about $41B 
in revenue. Today, there is widespread belief in this country 
that a lot of trading activity is unproductive, and we also 
have a serious deficit problem. My colleague Senator Tom Harkin 
has a bill for a FTT that would be 3 basis points and that the 
Joint Tax Committee has scored at $350 billion in revenue.
    Do you think that this tax would succeed at raising revenue 
while making our stock markets less about flash trading and 
more about real value investing?

A.1. Existing studies present mixed evidence on the net effect 
of FTTs on revenues. A 2011 European Commission working paper 
presents evidence that, despite a relatively low tax rate, the 
U.K. stamp duty has generated substantial revenue over the last 
decade. However, a different academic study found that when 
Sweden implemented an FTT in the 1980s, the country experienced 
a net loss in revenue as investors, in an effort to avoid the 
tax, moved trades offshore.
    While an FTT likely would discourage high frequency trading 
in financial markets that are subject to the tax, studies of 
the effect of FTTs on asset market price volatility show mixed 
results. One study by staff at the International Monetary Fund 
found that FTTs are associated with an increase in volatility, 
possibly resulting from lower trading volume and reduced 
liquidity caused by FTTs. Another study of the U.K. stamp tax 
found no significant effect of the tax on the volatility of 
U.K. equity prices, though intermediaries like broker-dealers 
are exempt from the U.K. stamp duty (but would not be under the 
European FTT). A study by Federal Reserve staff of the 2010 
U.S. ``flash crash,'' a day in which U.S. equity markets 
exhibited extremely high volatility, found that although high 
frequency trading did not cause or prevent the ``flash crash,'' 
it did exacerbate volatility on that day. \1\
---------------------------------------------------------------------------
     \1\ Kirilenko, Andrei A., Kyle, Albert S., Samadi, Mehrdad, and 
Tuzun, Tugkan, ``The Flash Crash'', The Impact of High Frequency 
Trading on an Electronic Market (May 26, 2011). Available at SSNR: 
http://ssrn.com/abstract=1686004 or http://dx.doi.org/10.2139/
ssrn.1686004.
---------------------------------------------------------------------------
    Further considerations of the FTT may include its impact on 
market efficiency, security valuation, and the cost of capital 
for corporations. Some academic studies have suggested that if 
FTTs result in reduced trading volume and diminished market 
liquidity, then they may hamper the price discovery process in 
financial markets, so that asset prices are less able to 
quickly reflect changes in economic and financial market 
conditions. Other studies have found that the implementation of 
FTTs is associated with lower equity prices, and thus higher 
costs of capital for domestic firms, which may discourage 
investment.

Q.2. What do you think the impact will be on the markets of the 
FTT taking affect across Europe?

A.2. The impact is very difficult to assess at this stage. The 
FTT proposal is still at a relatively early stage, with many 
important details yet to be determined, and the details matter 
to its impact. Moreover, as noted previously, existing evidence 
about the impact of FTTs is inconclusive.
    As with any tax, market participants will try to avoid it, 
and in the case of trading may try to do so by locating their 
trading activity elsewhere in the world. Their ability and 
willingness to do so is likely to depend greatly on the details 
of the tax and on the details of transaction taxes in other 
jurisdictions. At the margin, trading activity is likely to 
migrate to jurisdictions without such taxes, especially in the 
case of over-the-counter trading that does not require an 
exchange.

Q.3. It has been exactly a century since Congress designed the 
Fed structure that is still to a large extent in place today, 
and a lot of people might be surprised to know that bankers get 
to select the Class A and Class B boards of directors of the 
regional Federal Reserve banks. That means, of course, that 
oftentimes they select themselves. So, for example, when the 
New York Federal Reserve Bank played a central role in the 2008 
bank bailouts, it had big bank CEOs on its boards at that time. 
There are real advantages of Federal Reserve officials 
consulting with banks to understand what is going on, but, at 
the same time, a lot of people worry about the influence the 
biggest banks have on our Government.
    Do you think it still makes sense for bank executives to be 
able to select Class A and Class B directors at the regional 
Feds?

A.3. Congress designed the structure of the Federal Reserve 
System to give it a broad perspective on the economy and on 
economic activity in all parts of the Nation and to provide the 
Reserve Banks, as the operational arms of the central bank, 
with banking experience on their boards of directors. The 
public-private structure of a Government agency composed of 
presidentially appointed and Senate-confirmed members that 
oversee 12 banks with stock ownership and some directors chosen 
by member banks also allowed Congress to fund the Federal 
Reserve System with capital paid-in by member banks rather than 
the taxpayer. Congress chose also to include a two-thirds 
majority of representatives of other parts of the economy, 
including representatives from agriculture, commerce, industry, 
services, labor, and consumers, including three nonbankers 
chosen by the Board of Governors.
    The Federal Reserve recognizes the potential conflicts of 
interest that could arise from the statutory requirement that 
the boards of directors of Reserve Banks be comprised of the 
presence of bankers and other private citizens. As a result, 
the Federal Reserve has long had policies in place that prevent 
members of the Reserve Bank boards of directors (from any class 
of directors) from participating in any lending decisions 
involving the discount window or an emergency credit facility, 
having access to confidential supervisory information, or 
participating in setting regulatory or supervisory policies.
    The GAO, in its Report No. 12-18 regarding Federal Reserve 
Bank governance, confirmed that the Federal Reserve has 
policies in place that are effective in addressing these 
conflicts of interest. The GAO also noted in that report that, 
in choosing Class C directors, the Federal Reserve Board makes 
it a priority to encourage selection of directors that 
represent broad and diverse perspectives.

Q.4. What would be the advantages and disadvantages of Congress 
taking action to make the regional Fed boards more independent 
of the bankers they regulate?

A.4. As explained above, the Federal Reserve has taken 
important steps to ensure that the boards of directors of 
Reserve Banks are not involved in supervision or regulation of 
banking entities. Moreover, Congress in the Dodd-Frank Act 
reinforced these policies by eliminating the role of Class A 
directors in the selection of the Reserve Bank presidents. The 
GAO recognized that the Federal Reserve Board and Reserve Banks 
have been sensitive to avoid both potential and perceived 
conflicts of interest associated with a statutorily mandated 
governance structure that includes bankers on the boards of 
Reserve Banks. For example, the report confirmed that Reserve 
Bank directors are not involved in supervision and regulation 
activities, such as examinations and enforcement actions. The 
GAO also confirmed that Reserve Bank directors took no part in 
approving loans extended to banks through the discount window 
or other emergency liquidity facilities, and that institutions 
with representatives on Reserve Bank boards were not given 
special treatment at the discount window or at emergency 
liquidity facilities.
    The Federal Reserve Board believes that representation on 
Reserve Bank boards of directors by local bankers, as well as 
participants in other aspects of the real economy helps provide 
a broad perspective on the economy in various Reserve Bank 
districts. Reducing this avenue of information would weaken 
that insight without providing any significant advantage to 
Federal Reserve supervision or regulation of banks.

Q.5. In the wake of Canning v. NLRB, some commentators have 
questioned whether CFPB Director Rich Cordray's recess 
appointment in 2011 was a valid use of the President's 
executive powers. While there is abundant evidence that 
Director Cordray's appointment was valid and that assertions to 
the contrary are based on flawed legal reasoning, the ongoing 
assault on the President's attempts to nominate a Director to 
the CFPB has nonetheless created additional anxiety in the 
marketplace. In particular, some commentators have argued that, 
if the Director's recess appointment was invalid, then the 
CFPB's recently issued mortgage rules are also invalid, and 
thus various Dodd-Frank default mortgage requirements in Title 
IV were instead operative as of January 21, 2013. While I 
disagree strongly with that view, some have expressed concern 
that many financial institutions would be out of compliance 
with the law if the Dodd-Frank rules are in fact in effect.
    Can you reassure investors or others who are concerned 
about mortgage issuers' potential legal exposure from 
noncompliance with the Dodd-Frank automatic rules that the 
risks are not sufficient to pose a safety and soundness threat 
to individual banks or systemic threat to the economy?

A.5. We expect banking organizations and other entities that 
are subject to oversight by the prudential regulators to assess 
the legal and other applicable risks in connection with their 
mortgage lending activities and to properly manage these risks, 
which includes using prudent underwriting standards. It is not 
clear how courts might eventually rule in determining whether 
the Dodd-Frank Act's default effective date applies, or the 
potential liabilities that might stem from any court decision.

Q.6. What do you believe is the cost to the ongoing uncertainty 
about CFPB's future?

A.6. The Federal Reserve has not conducted any qualitative or 
quantitative analysis regarding the cost of any uncertainty 
about the CFPB's future and thus has no estimates as to any 
such cost.

Q.7. Has the Federal Reserve conducted any analysis regarding 
the ongoing cost of uncertainty about CFPB's future? If so, can 
you share it with the Committee?

A.7. Please see response for [Question 6].
                                ------                                


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

Q.1. Are there any individual financial institutions whose 
failure would pose a systemic risk to the United States? Are 
there currently any financial institutions so large or so 
complex that their failure would threaten the financial 
stability of the United States? If so, how do you plan to 
resolve this issue?

A.1. The Dodd-Frank Act contemplates three types of financial 
institution whose failure could potentially pose a systemic 
risk to the United States. These include bank holding companies 
with greater than $50 billion in assets, nonbank financial 
companies designated by the Financial Stability Oversight 
Council (``FSOC'' or ``Council''), and financial market 
utilities (FMUs) designated by the Council. In accordance with 
the Dodd-Frank Act, the Federal Reserve has developed enhanced 
prudential standards under Section 165 and 166 to reduce the 
risk posed by the first two of these categories of 
institutions, including regular stress tests, capital 
requirements, counterparty credit limits, and more. Bank 
holding companies with $50 billion or greater in assets have 
been identified and are subject to these standards. In 
addition, the Council has issued a final rule and interpretive 
guidance pursuant to which the Council is considering nonbank 
financial companies for designation. The Council also 
designated eight FMUs under its Dodd-Frank authority, and those 
firms are now subject to the enhanced standards issued by the 
relevant supervisory agencies, including the Federal Reserve.
    As a supervisory agency, the Federal Reserve has also 
instituted a merger screen that considers the financial 
stability implications of mergers or acquisitions proposed by 
its largest firms, and, as a member of the Basel Committee on 
Banking Supervision and the Financial Stability Board, has 
supported additional capital requirements for firms that are 
found to be systemically important internationally. While these 
measures have not eliminated the risk posed by these firms, 
measures such as the capital requirements and surcharges on the 
largest financial institutions will help to equalize their cost 
of funding with other banks and make them safer so that the 
risk of their failure is more limited.
                                ------                                


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

Q.1. Mr. Chairman, as you know, numerous Senators have weighed 
in with the Board of Governors that, in enacting Dodd-Frank, 
Congress intended to utilize State-risk based capital rules 
governing capital for insurance-based SLHCs. As you have heard 
in your recent appearances before the House Financial Services 
and Senate Banking Committees, many of us remain deeply 
troubled by the Federal Reserve's insistence in applying bank-
centric standards to such companies. In particular, Senator 
Collins has written to you pointing out that ``it was not 
Congress' intent that Federal regulators supplant prudential 
State-based insurance regulation with a bank-centric capital 
regime.'' In your recent appearance before the House Financial 
Services Committee, however, you indicated the Board of 
Governors was constrained by the Collins Amendment in 
addressing the insurance-banking distinction.
    Given that the statute does not preclude utilizing 
insurance capital standards to satisfy minimum capital 
requirements that are equivalent to Basel standards, and that 
congressional intent is now clear on permitting the use of such 
insurance standards, will the Board continue to insist that the 
Collins Amendment mandates the use of bank-centric standards 
for insurance-based SLHCs and grants the Board no flexibility 
or discretion in this area? If so, could you provide the legal 
rationale as to why the Board of Governors believes it has no 
such flexibility and discretion?

A.1. Section 171 of the Dodd-Frank Act, by its terms, requires 
the appropriate Federal banking agencies to establish minimum 
capital requirements for bank holding companies (BHCs) and 
savings and loan holding companies (SLHCs) that ``shall not be 
less than'' ``nor quantitatively lower than'' the generally 
applicable capital requirements for insured depository 
institutions. Section 171 does not contain an exception from 
these requirements for an insurance company that is a BHC or an 
SLHC, or for a BHC or an SLHC that controls an insurance 
company.
    To allow the Board an additional opportunity to consider 
prudent approaches to establish capital requirements for SLHCs 
that engage substantially in insurance activities within the 
requirements of the terms of section 171, the Board, on July 2, 
2013, determined to defer application of the new Basel III 
capital framework to SLHCs with significant insurance 
activities (i.e., those with more than 25 percent of their 
assets derived from insurance underwriting activities other 
than credit insurance) and to SLHCs that are themselves state 
regulated insurance companies. After considering the concerns 
raised by commenters regarding the proposed application of the 
proposed regulatory capital rules to SLHCs with significant 
insurance activities, the Board concluded that it would be 
appropriate to take additional time to evaluate the appropriate 
capital requirements for these companies in light of their 
business models and risks. Among other issues, commenters 
argued that the final capital rules should take into account 
insurance company liabilities and asset-liability matching 
practices, the risks associated with separate accounts, the 
interaction of consolidated capital requirements with the 
capital requirements of State insurance regulators, and 
differences in accounting practices for banks and insurance 
companies. The Board is carefully considering these issues in 
determining how to move forward in developing a capital 
framework for these SLHCs, consistent with section 171 of the 
Dodd-Frank Act.
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