[Senate Hearing 113-473, Volume 1]
[From the U.S. Government Publishing Office]





                             
                                                S. Hrg. 113-473, Vol. I

        FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2014
=======================================================================

                                HEARING

                               before the

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

                    ONE HUNDRED THIRTEENTH CONGRESS

                             SECOND SESSION

                                VOLUME I

                                   ON

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

                               ----------                              

                             JULY 15, 2014

                               ----------                              

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



[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]










                                                S. Hrg. 113-473, Vol. I


        FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2014

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

                                HEARING

                               before the

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

                    ONE HUNDRED THIRTEENTH CONGRESS

                             SECOND SESSION

                                VOLUME I

                                   ON

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

                               __________

                             JULY 15, 2014

                               __________

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

[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]


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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

                   Glen Sears, Deputy Policy Director

         Brett Hewitt, Policy Analyst and Legislative Assistant

                      Dan Fitchler, FSOC Detailee

                  Greg Dean, Republican Chief Counsel

             Mike Lee, Republican Professional Staff Member

              Jelena McWilliams, Republican Senior Counsel

              Elad Roisman, Republican Securities Counsel

                       Dawn Ratliff, Chief Clerk

                       Taylor Reed, Hearing Clerk

                      Shelvin Simmons, IT Director

                          Jim Crowell, Editor

                                  (ii)





















                            C O N T E N T S

                              ----------                              

                         TUESDAY, JULY 15, 2014

                                                                   Page

Opening statement of Chairman Johnson............................     1

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

                                WITNESS

Janet L. Yellen, Chair, Board of Governors of the Federal Reserve 
  System.........................................................     3
    Prepared statement...........................................    33
    Responses to written questions of:
        Senator Crapo............................................    36
        Senator Menendez.........................................    44
        Senator Vitter...........................................    45
        Senator Johanns..........................................    45
        Senator Toomey...........................................    47
        Senator Moran............................................    52
        Senator Coburn...........................................    55

              Additional Material Supplied for the Record

Monetary Policy Report to the Congress dated July 15, 2014.......  1643
Chart submitted by Senator Patrick J. Toomey.....................  1701

                                 (iii)

 
        FEDERAL RESERVE'S SECOND MONETARY POLICY REPORT FOR 2014

                              ----------                              


                         TUESDAY, JULY 15, 2014

                                       U.S. Senate,
          Committee on Banking, Housing, and Urban Affairs,
                                                    Washington, DC.
    The Committee met at 10:03 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. I call this hearing to order.
    This morning we welcome Chair Yellen back to the Committee 
for testimony on the Federal Reserve's semiannual Monetary 
Policy Report to the Congress. Since Chair Yellen was last 
before the Committee, Stanley Fischer, Lael Brainard, and 
Jerome Powell were confirmed by the Senate to serve on the 
Board. It is important that the Fed maintain a full complement 
of Governors to effectively carry out its monetary policy and 
regulatory functions. To that end, there are two remaining 
spots to be filled on the Board, and I hope for the swift 
nomination of well-qualified candidates with expertise in 
community banking, as well as tough and effective oversight 
experience.
    The Fed continues to grapple with many pressing issues that 
span both monetary and regulatory policy, and I look forward to 
hearing Chair Yellen's perspective on these issues today. The 
steady path to economic recovery following the Great Recession 
took a sidestep with first quarter GDP falling. The 
unemployment rate has continued to drop in recent months, but 
long-term unemployment and youth unemployment remain 
unacceptably high. And the housing sector has been slow to 
rebound from its troubles during the crisis, with too many 
creditworthy borrowers locked out of the mortgage market.
    Given these headwinds against a more robust recovery and a 
low inflation rate, I am encouraged by the FOMC's view that 
monetary policy will likely remain accommodative for a 
considerable time following the completion of the Fed's asset 
purchase program.
    I am also encouraged by the continued progress being made 
to implement Wall Street reform and improve U.S. financial 
stability. Chair Yellen, your recent comments outlining the 
importance of macroprudential tools that lean against financial 
excesses and focus on building resilience in the financial 
system rightly point to the need to ensure that firms--
particularly the largest and most systemically important 
firms--are prepared for the worst and able to withstand shocks 
from a variety of sources.
    To that end, it is imperative that Wall Street reform rules 
be completed as soon as possible. We must not forget how costly 
the last financial crisis has been, so regulators and Congress 
must continue to do all we can to keep our financial system 
stable and promote strong economic growth.
    With that, I will now turn to Ranking Member Crapo for his 
opening statement.

                STATEMENT OF SENATOR MIKE CRAPO

    Senator Crapo. Thank you, Mr. Chairman, and welcome, Chair 
Yellen.
    During Chair Yellen's, Dr. Yellen's nomination hearing, I 
noted the need to fill the additional vacancies that the 
Chairman referenced at the Federal Reserve Board with 
individuals bringing balanced viewpoints. Again, I stated the 
President should nominate someone with community bank 
experience to the Board to fill one of the remaining vacancies. 
Community banks play an important role in their local economies 
and face a disproportionate burden from regulation. We should 
ensure that the perspective of those banks is represented in 
regulatory policymaking.
    Today's hearing is another important opportunity to discuss 
monetary policy and financial regulatory policy. Since our last 
hearing with Chair Yellen, the Fed has continued to reduce the 
pace of its large-scale asset purchases, known as 
``quantitative easing'' or ``QE.'' It has been a welcome 
development to see that under the Chair's direction and that 
this process of tapering has begun and now we will likely be 
able to see all QE purchases cease later this year.
    I have consistently made my opposition to the policy of QE 
very clear. The quadrupling of the size of the Fed's balance 
sheet that has occurred as a result of the Fed's QE purchases 
of Treasury and agency-backed mortgage-backed securities is 
worrisome. These QE assets will remain on the Fed's balance 
sheet for a very long time, and the reserves used to purchase 
them will remain in the financial system.
    The process of normalizing monetary policy will be 
difficult, particularly in light of the fact that our economy 
has failed to strengthen in the way that was promised by the 
supporters of this unconventional monetary stimulus.
    Recent Federal Open Market Committee minutes indicate that 
in the coming years any miscommunication about monetary policy 
during this normalization period could create risks to the 
economic outlook. Continued clear communication will be 
important, particularly as the Fed is seeking to rely on new 
tools that are unfamiliar to the market.
    For example, Fed officials have indicated that overnight 
reverse purchase agreements, also known as ``repos,'' will 
likely play a large part in setting monetary policy during 
normalization, while the Federal funds rate becomes less 
important. At the FOMC meeting, some raised concerns that the 
Fed's overnight repo facility could increase problems during 
adverse market conditions, potentially causing counterparties 
to shift funds away from making loans and opting for the Fed's 
safety net instead.
    How will the Fed balance the need for open communication 
with the ability to preserve flexibility should unintended 
consequences arise in this important market?
    I am also interested in your recent comments on the use of 
macroprudential tools by the Fed. You specifically recognized 
that experience with these tools is limited and that many 
central banks will still have much to learn to use these 
measures effectively. Introducing the concept of managing U.S. 
monetary policy by regulations and prudential oversight is 
untested and perhaps more theoretical than real.
    I agree with those who are concerned that regulators may 
not be able to get the timing right. Many economists, including 
those at the Fed, have not been very good judges of identifying 
market bubbles and predicting when the bubbles will burst. Your 
speech discussed the ability of regulators to change regulatory 
standards on mortgage lending, such as debt-to-income and loan-
to-value ratios as a macroprudential tool that could slow 
mortgage lending.
    I am very skeptical that during a housing boom registration 
would ever act aggressively to restrict lending to individuals 
with high levels of debt or low incomes. In fact, recent 
experience suggests all the political pressures run counter to 
that happening.
    It is also highly questionable to think that forecasters 
will identify beforehand when these tools should be adjusted 
the credit cycle. While financial stability can complement the 
goals of monetary policy, it is paramount that the regulators 
strike the right balance without unduly harming the economy.
    Again, we have a lot of issues to deal with, and I look 
forward to your testimony today, Chair Yellen. Thank you.
    Chairman Johnson. Thank you, Senator Crapo.
    To preserve time for questions, opening statements will be 
limited to the Chair and Ranking Member. I would like to remind 
my colleagues that the record will be open for the next 7 days 
for additional statements and other materials.
    I would now like to welcome Chair Janet Yellen back to the 
Committee. Dr. Yellen is serving her first term as Chair of the 
Board of Governors of the Federal Reserve System. Prior to 
holding this position, Dr. Yellen served as Vice Chair of the 
Board for over 3 years. She has also previously served as Chair 
of the Council of Economic Advisers and President and CEO of 
the Federal Reserve Bank of San Francisco.
    Chair Yellen, it is good to see you once again. Please 
begin your testimony.

STATEMENT OF JANET L. YELLEN, CHAIR, BOARD OF GOVERNORS OF THE 
                     FEDERAL RESERVE SYSTEM

    Ms. Yellen. Thank you. Chairman Johnson, Ranking Member 
Crapo, and Members of the Committee, I am pleased to present 
the Federal Reserve's semiannual Monetary Policy Report to the 
Congress. In my remarks today, I will discuss the current 
economic situation and outlook before turning to monetary 
policy. I will conclude with a few words about financial 
stability.
    The economy is continuing to make progress toward the 
Federal Reserve's objectives of maximum employment and price 
stability.
    In the labor market, gains in total nonfarm payroll 
employment averaged about 230,000 per month over the first half 
of this year, a somewhat stronger pace than in 2013 and enough 
to bring the total increase in jobs during the economic 
recovery thus far to more than 9 million. The unemployment rate 
has fallen nearly 1\1/2\ percentage points over the past year 
and stood at 6.1 percent in June, down about 4 percentage 
points from its peak. Broader measures of labor utilization 
have also registered notable improvements over the past year.
    Real gross domestic product is estimated to have declined 
sharply in the first quarter. The decline appears to have 
resulted mostly from transitory factors, and a number of recent 
indicators of production and spending suggest that growth 
rebounded in the second quarter, but this bears close watching. 
The housing sector, however, has shown little recent progress. 
While this sector has recovered notably from its earlier 
trough, housing activity leveled off in the wake of last year's 
increase in mortgage rates, and readings this year have, 
overall, continued to be disappointing.
    Although the economy continues to improve, the recovery is 
not yet complete. Even with the recent declines, the 
unemployment rate remains above the Federal Open Market 
Committee participants' estimates of its longer-run normal 
level. Labor force participation appears weaker than one would 
expect based on the aging of the population and the level of 
unemployment. These and other indications that significant 
slack remains in labor markets are corroborated by the 
continued slow pace of growth in most measures of hourly 
compensation.
    Inflation has moved up in recent months but remains below 
the FOMC's 2-percent objective for inflation in the longer run. 
The personal consumption expenditures, or PCE, price index 
increased 1.8 percent over the 12 months through May. Pressures 
on food and energy prices account for some of the increase in 
PCE price inflation. Core inflation, which excludes food and 
energy prices, rose 1.5 percent. Most committee participants 
project that both total and core inflation will be between 1\1/
2\ and 1\3/4\ percent for this year as a whole.
    Although the decline in GDP in the first quarter led to 
some downgrading of our growth projections for this year, I and 
other FOMC participants continue to anticipate that economic 
activity will expand at a moderate pace over the next several 
years, supported by accommodative monetary policy, a waning 
drag from fiscal policy, the lagged effects of higher home 
prices and equity values, and strengthening foreign growth. The 
committee sees the projected pace of economic growth as 
sufficient to support ongoing improvement in the labor market 
with further job gains, and the unemployment rate is 
anticipated to continue to decline toward its longer-run 
sustainable level. Consistent with the anticipated further 
recovery in the labor market, and given that longer-term 
inflation expectations appear to be well anchored, we expect 
inflation to move back toward our 2-percent objective over 
coming years.
    As always, considerable uncertainty surrounds our 
projections for economic growth, unemployment, and inflation. 
FOMC participants currently judge these risks to be nearly 
balanced but to warrant monitoring in the months ahead.
    I will now turn to monetary policy. The FOMC is committed 
to policies that promote maximum employment and price 
stability, consistent with our dual mandate from the Congress.
    Given the economic situation that I just described, we 
judge that a high degree of monetary policy accommodation 
remains appropriate. Consistent with that assessment, we have 
maintained the target range for the Federal funds rate at 0 to 
\1/4\ percent and have continued to rely on large-scale asset 
purchases and forward guidance about the path of the Federal 
funds rate to provide the appropriate level of support for the 
economy.
    In light of the cumulative progress toward maximum 
employment that has occurred since the inception of the Federal 
Reserve's asset purchase program in September 2012 and the 
FOMC's assessment that labor market conditions would continue 
to improve, the committee has made measured reductions in the 
monthly pace of our asset purchases at each of our regular 
meetings this year. If incoming data continue to support our 
expectation of ongoing improvement in labor market conditions 
and inflation moving back toward 2 percent, the committee 
likely will make further measured reductions in the pace of 
asset purchases at upcoming meetings, with purchases concluding 
after the October meeting. Even after the committee ends these 
purchases, the Federal Reserve's sizable holdings of longer-
term securities will help maintain accommodative financial 
conditions, thus supporting further progress in returning 
employment and inflation to mandate-consistent levels.
    The committee is also fostering accommodative financial 
conditions through forward guidance that provides greater 
clarity about our policy outlook and expectations for the 
future path of the Federal funds rate. Since March, our 
postmeeting statements have included a description of the 
framework that is guiding our monetary policy decisions. 
Specifically, our decisions are and will be based on an 
assessment of the progress--both realized and expected--toward 
our objectives of maximum employment and 2 percent inflation. 
Our evaluation will not hinge on one or two factors but, 
rather, will take into account a wide range of information, 
including measures of labor market conditions, indicators of 
inflation and long-term inflation expectations, and readings on 
financial developments.
    Based on its assessment of these factors, in June the 
committee reiterated its expectation that the current target 
range for the Federal funds rate likely will be appropriate for 
a considerable period after the asset purchase program ends, 
especially if projected inflation continues to run below the 
committee's 2-percent longer-run goal and provided that 
inflation expectations remain well anchored. In addition, we 
currently anticipate that even after employment and inflation 
are near mandate-consistent levels, economic conditions may, 
for some time, warrant keeping the Federal funds rate below 
levels that the committee views as normal in the longer run.
    Of course, the outlook for the economy and financial 
markets is never certain, and now is no exception. Therefore, 
the committee's decisions about the path of the Federal funds 
rate remain dependent on our assessment of incoming information 
and the implications for the economic outlook. If the labor 
market continues to improve more quickly than anticipated by 
the committee, resulting in faster convergence toward our dual 
objectives, then increases in the Federal funds rate target 
likely would occur sooner and be more rapid than currently 
envisioned. Conversely, if economic performance is 
disappointing, then the future path of interest rates likely 
would be more accommodative than currently anticipated.
    The committee remains confident that it has the tools it 
needs to raise short-term interest rates when the time is right 
and to achieve the desired level of short-term interest rates 
thereafter, even with the Federal Reserve's elevated balance 
sheet. At our meetings this spring, we have been constructively 
working through the many issues associated with the eventual 
normalization of the stance and conduct of monetary policy. 
These ongoing discussions are a matter of prudent planning and 
do not imply any imminent change in the stance of monetary 
policy. The committee will continue its discussions in upcoming 
meetings, and we expect to provide additional information later 
this year.
    The committee recognizes that low interest rates may 
provide incentives for some investors to ``reach for yield,'' 
and those actions could increase vulnerabilities in the 
financial system to adverse events. While prices of real 
estate, equities, and corporate bonds have risen appreciably 
and valuation metrics have increased, they remain generally in 
line with historical norms. In some sectors, such as lower-
rated corporate debt, valuations appear stretched and issuance 
has been brisk. Accordingly, we are closely monitoring 
developments in the leveraged loan market and are working to 
enhance the effectiveness of our supervisory guidance. More 
broadly, the financial sector has continued to become more 
resilient, as banks have continued to boost their capital and 
liquidity positions, and growth in wholesale short-term funding 
in financial markets has been modest.
    In sum, since the February Monetary Policy Report, further 
important progress has been made in restoring the economy to 
health and in strengthening the financial system. Yet too many 
Americans remain unemployed, inflation remains below our 
longer-run objective, and not all of the necessary financial 
reform initiatives have been completed. The Federal Reserve 
remains committed to employing all of its resources and tools 
to achieve its macroeconomic objectives and to foster a 
stronger and more resilient financial system.
    Thank you. I would be pleased to take your questions.
    Chairman Johnson. Thank you for your testimony.
    As we begin questions, will the clerk please put 5 minutes 
on the clock for each Member?
    Chair Yellen, there seems to be mixed signals about the 
economy. In the face of these mixed signals, how cautiously 
will the Fed proceed as it considers ending large-scale asset 
purchases?
    Ms. Yellen. Chairman Johnson, as you know, there are mixed 
signals concerning the economy. Most importantly, GDP growth is 
reported by the Bureau of Economic Analysis to have declined 
almost 3 percent at an annual rate in the first quarter.
    That said, many indicators concerning the economy, 
indicators of spending and production, are substantially more 
positive than that. As I noted, the labor market throughout 
that period has also continued to improve, and at a somewhat 
faster rate than we had seen previously. Indicators of consumer 
sentiment and of business sentiment and optimism also seem to 
be positive.
    So my reading at the present time is that the GDP decline 
is largely due to factors I would judge to be transitory, and I 
do think that that negative number substantially understates 
the momentum in the economy. But, of course, this is something 
we need to watch very carefully and are doing so. Nevertheless, 
my overall view is more positive.
    Now, as I mentioned, the labor market, I believe, has been 
improving. Not only has the unemployment rate been declining, 
but broader measures of performance of the labor market have 
also shown improvement, and that is important. This is, of 
course, exactly what we want to achieve. But the Federal 
Reserve does need to be quite cautious with respect to monetary 
policy. We have in the past seen sort of false dawns, periods 
in which we thought growth would speed, pick up, and the labor 
market would improve more quickly, and later events have proven 
those hopes to be unfortunately overoptimistic.
    So we are watching very carefully, especially when short-
term overnight rates are at zero, so we have no ability to 
lower them further. We need to be careful to make sure that the 
economy is on a solid trajectory before we consider raising 
interest rates. And I think the forward guidance that we have 
provided in the policies that we have put in place are 
providing a great deal of accommodation to the economy to make 
sure that it is on a sound trajectory.
    Chairman Johnson. Pertaining to the Collins amendment, the 
Senate recently passed legislation to clarify the Fed's ability 
to apply insurance-specific capital standards to insurance 
companies overseas. Why is it important that Congress act 
quickly and pass this legislation?
    Ms. Yellen. Well, as my colleagues and I have made clear on 
many occasions, our objective in designing regulations for 
insurance companies that come under our supervision or other 
nonbank SIFIs will be to tailor to suit the needs and special 
characteristics of the entities that we supervise, and we are 
certainly trying to achieve that in the case of the insurance 
entities that we supervise.
    But there are constraints on our ability to tailor 
appropriate regulations, and the Collins amendment does pose 
constraints. So I think it would be useful to increase 
flexibility to allow us greater latitude in tailoring 
appropriate regulations.
    Chairman Johnson. In light of your recent speech, will you 
elaborate on how you envision the Fed using macroprudential 
tools instead of monetary policy to maintain financial 
stability and build resilience in the financial system?
    Ms. Yellen. I think most importantly we have substantially 
strengthened the capital and liquidity positions of banking 
firms and financial firms that we supervise more generally. Our 
objective is to make sure that these firms are on solid 
footing, and to the extent that the financial system or the 
economy are buffeted with shocks, that these firms will be 
resilient, that they can continue to lend to support the credit 
needs of our economy even under adverse circumstances. And I 
would say our stress tests are a very important part of that as 
well.
    So, first and foremost, the entire agenda from Dodd-Frank 
and more broadly coming out of the financial crisis to see a 
more resilient, better capitalized financial system, banking 
system, I would say is the core of that effort. If there were 
an asset price bubble and we did not intervene effectively to 
deal with that and that bubble burst, we want to make sure that 
the financial system can withstand such a shock, and that is an 
objective of our efforts.
    We can also use more targeted tools that try to make sure 
that, as business cycle conditions improve as we go into more 
robust boom times, that, for example, in our stress tests we 
have automatically designed the scenarios to impose a more 
severe stress that firms need to be able to survive as asset 
prices increase and the economy grows more robust.
    Those are the kinds of tools I largely have in mind.
    Chairman Johnson. Senator Crapo.
    Senator Crapo. Thank you, Mr. Chairman.
    Chair Yellen, in your testimony you mentioned that you 
currently anticipate that the Federal funds rate will continue 
below levels that the committee views as normal for an extended 
period of time. You also added that, depending on the economic 
outlook, this rate increase could occur sooner or later, as we 
get a better feeling for the strength of the economy.
    Based on your view of the economy and the markets, when do 
you currently anticipate this first rate hike to occur?
    Ms. Yellen. The Committee has given guidance that says what 
we will be looking at is the progress we are making toward our 
two congressionally mandated objectives--maximum employment and 
price stability or our 2-percent inflation goal. There is no 
formula and there is no mechanical answer that I can give you 
about when the first rate increase will occur. It will depend 
on the progress of the economy and how we assess it based on a 
variety of indicators.
    To get a sense of the views that members of our committee 
hold, included in the Monetary Policy Report is a summary of 
economic projections that all participants in the FOMC provided 
at the beginning of our June meeting. So these projections are 
just that. They depend on each participant's own personal 
economic outlook, and they are not a policy statement of the 
FOMC. But they provide some sense of concretely what 
participants expected at the beginning of that meeting. And 
those projections show that almost all participants anticipate 
that the first increase in the Federal funds rate, if things 
continue on the trajectories they expect, would come sometime 
in 2015, and the median projection for where the Federal funds 
rate would stand at the end of that year was around 1 percent, 
so a positive but relatively low level. And I think that gives 
you a feeling for what participants thought would be 
appropriate given their projections in June.
    I want to emphasize, as I have said repeatedly, that what 
actually happens, our projections change with incoming data. 
The economy is uncertain, and what will actually happen clearly 
is going to depend on the progress the economy makes.
    Senator Crapo. Thank you.
    Ms. Yellen. But I think that is consistent with the forward 
guidance that is contained in the FOMC statement as well.
    Senator Crapo. Thank you. And based on the minutes of the 
most recent FOMC meetings, the discussion of monetary policy 
normalization has become an important topic for the committee. 
One of the strategies that is discussed is that the Fed will 
drain reserves by lending its securities out to the market as a 
part of reverse purchase agreements, or repos.
    There is concern that such a facility would be a safe haven 
in times of market street, attracting large funds and depriving 
business of credit. Is this a concern of yours? And how would 
the Fed address the potential that the facility could aggravate 
a market crisis?
    Ms. Yellen. Let me say that these are matters that we are 
discussing in an ongoing basis, and no final decisions have 
been made about the precise strategy that we will use when the 
time comes to normalize monetary policy. But we have tried to 
provide in the minutes a very good summary of the thinking in 
the Committee as these discussions have taken place.
    One of the challenges we face is, as you mentioned in your 
opening remarks, the Fed's balance sheet is very large; there 
are very large quantity of reserves in the banking system; and 
because of that, that poses some limits on our ability to 
precisely control the Federal funds rate. We cannot really use 
quite the same strategy of intervention we used prior to the 
crisis. So we have indicated that the main tool we will use is 
the interest rate we pay on overnight reserves. The overnight 
RRP facility that you referred to I think of as a back-up tool 
that will be used to help us control the Federal funds rate, to 
improve our control over the Federal funds rate.
    I think it is a very useful and effective tool. We have 
gleaned that from the initial testing that we have done. But as 
you mention, we do have concerns about allowing that facility 
to become too large or to play too prominent a role, and for 
precisely the reason that you gave. If stresses were to develop 
in the market, in effect it provides a safe haven that could 
cause flight from lending to other participants in the money 
markets. So two tools that we can use and are discussing to 
control those risks. One would be to maintain a relatively 
large spread between the interest rate we pay on overnight 
reverse RPs and the interest rate on excess reserves. The 
larger that spread, the less use that facility will be.
    Also, we can contemplate limits on the extent to which it 
can be used, either aggregate limits or limits that would apply 
to individual participants, and all of that is figuring into 
our discussions.
    Senator Crapo. Thank you
    Chairman Johnson. Senator Reed.
    Senator Reed. Thank you very much, Mr. Chairman, and thank 
you, Madam Chairwoman. You pointed out obviously that the 
mandate or one of the mandates of the Fed is full employment. 
We have seen some progress, but there have been variations 
regionally. My State still suffers from a significant 
unemployment crisis. And also underlying the overall statistics 
is the persistently high long-term unemployment number.
    Can you comment about what the Fed is doing to try to 
address these two specific issues and further comment upon 
whether, as I feel, Congress can complement your efforts by 
reinstating long-term unemployment benefits for these people?
    Ms. Yellen. As you note, nationally long-term unemployment 
is at almost unprecedented levels historically, and the average 
duration of unemployment spells is extremely long. And also, of 
course, there are variations from State to State in the level 
of unemployment with some States seeing much lower unemployment 
than the national average and the reverse.
    Our monetary policy really cannot affect things at the 
level of individual States, and we have no specific tools to 
target long-term unemployment, but my expectation is that as 
the national unemployment rate comes down and if the pace of 
job creation stays where it is or even rises, I expect to see 
improvements on all fronts. And, in fact, long-term 
unemployment has declined, and the evidence that I have seen, 
although perhaps not utterly definitive, suggests that the 
decline in long-term unemployment does on balance reflect those 
who have experienced long spells getting jobs and moving into 
employment and not simply becoming so discouraged that they 
move out of the labor force.
    So that is a healthy development, and, you know, while 
long-term unemployment remains at exceptionally high levels and 
is a grave concern, I do think we are seeing improvements as 
the job market is strengthening. And I think in every State we 
should expect to see--as confidence in the recovery grows and 
it strengthens, we should definitely expect to see 
improvements.
    Senator Reed. You point out that the Federal Reserve's 
monetary policies have limitations, but fiscal policies of the 
Congress can be much more proactive in terms of, one, 
unemployment benefits so that these people have some support as 
they look for and do not get discouraged in their quest for 
jobs; and, second, infrastructure and a host of programs. And I 
would assume you would see these as complementary to your goal 
and necessary to your goal.
    Ms. Yellen. Senator, I think that these are really matters 
for Congress to debate and decide. With respect to long-term 
unemployment benefits, obviously we have a situation where 
long-term unemployment is far more common in the population and 
imposing serious tolls.
    Senator Reed. You do not have to respond, but my sense is 
that for the last several years you have been the only game in 
town in terms of trying to deal with this issue, because we 
have not taken some of the actions that we could that would 
have been beneficial and see us at a much better situation 
today. So----
    Ms. Yellen. Fiscal policy has been, I think CBO would 
confirm, a significant drag on the recovery, and fortunately 
that is diminishing. And, in fact, I think that is one of the 
positives for the economic outlook for economic growth going 
forward.
    Senator Reed. Well, thank you. I hope you are right.
    Ms. Yellen. I hope so, too.
    Senator Reed. Just quickly changing the subject and 
probably making a point, because my time is rapidly 
diminishing, the Federal Reserve in 2011 had a program, 
independent foreclosure review process, which they were trying 
to help people who had been mis-served by the foreclosure 
process services. That was scrapped shortly afterwards, and 
essentially you went to a direct payment sort of form, about 
$3.9 billion. I am told that that program still has cash on 
hand, that you have not been able to reach the people, people 
receiving checks have not cashed them, or do not intend to.
    This residual money, can you reprogram to State agencies or 
local initiatives that are much more effective in getting the 
money out? Could you consider that?
    Ms. Yellen. No decision at all has been made at this point 
on what to do with residual funds, and so there may be a number 
of options. We have yet to debate that.
    Senator Reed. Well, again, there are States, you know, and 
regions that need this help, and if you could get the money to 
the people who can get it out, that would be, I think, 
positive. Thank you, Madam Chairwoman.
    Chairman Johnson. Senator Vitter.
    Senator Vitter. Thank you, Mr. Chairman. Thank you, Madam 
Chair, for being here and for your work.
    This week, on the Senate floor, through the TRIA bill, the 
Senate is expected to adopt and pass my amendment to mandate 
that at least one member of the Federal Reserve Board have 
direct community bank or community bank supervisory experience. 
What is your reaction to that mandate?
    Ms. Yellen. Senator, I would welcome the appointment of a 
community banker to our Board. I think a community banker can 
add a great deal to the work that we do, and I have worked with 
community bankers like Governor Duke or community bank 
supervisors like then-Governor Raskin and have seen how much 
that experience can contribute to our work. So----
    Senator Vitter. Great
    Ms. Yellen. I am very positive on the idea of having a 
community banker appointed to the Board.
    That said, I do not support requiring it via legislation. 
There are seven Governorships. The Board has many different 
needs. I think if we were to sit down and make a list of all of 
the kinds of expertise that are needed and are useful, there 
would be more than seven items on that list. And I would, you 
know, prefer to see appointments made in light of the 
priorities, including for a community banker, rather than for 
the indefinite future locking in and earmarking particular 
seats for particular purposes. I feel that is a road that could 
go further in a direction that would worry me. If we are 
earmarking, we could end up earmarking each seat for a 
particular kind of expertise, and I think greater flexibility 
needs do change over time. But that is not in any way to 
diminish my support for seeing a community banker appointed to 
the Board.
    Senator Vitter. Well, we look forward to this community 
bank experience being more forcefully put on the Board through 
this legislation, so we will agree on that and look forward to 
it.
    Madam Chair, we have talked a lot over your various visits 
about too big to fail. It is a concern of mine and other 
Members of the Committee on both sides of the aisle. And what I 
have personally heard is your agreeing with that general 
concern, but I have not really seen that translate into 
concrete policy moves to curb and change the continuation of 
too big to fail. That is my opinion.
    So in that context, you were last before us on February 
27th. What, if any, specific policy changes, initiatives, 
movement has the Fed or other regulators taken to curb and help 
end too big to fail?
    Ms. Yellen. We have finalized our Basel III capital 
requirements that significantly increase the quality and 
quantity of capital in the banking system. Even before we did 
that, through our stress tests, we have worked to ensure that 
especially the largest and most systemic institutions have the 
ability to not only survive a very adverse stress to the 
system, but also to lend and support the needs of the economy 
through such a stress. The amount of capital in the banking 
system has basically doubled since 2009. We have put out for 
comment a liquidity coverage ratio rule that we hope to 
finalize this year. We are in the process of working through a 
regulation that will implement so-called SIFI surcharges or 
surcharges for the largest, most systemic firms. We have 
finalized and enhanced a higher leverage standard for the eight 
largest firms in the United States. And we are working very 
hard to make sure that these firms are resolvable in the event 
they should encounter a stress that overwhelms those 
substantial defenses. The FDIC, under its orderly liquidation 
authority, has the ability to resolve such a firm. It has 
established an architecture for doing so, and the United States 
is working with other global regulators to think through how 
that authority could be exercised to deal with cross-border 
issues.
    We are discussing in the United States and globally a 
requirement for the largest and most systemic organizations to 
hold sufficient unsecured long-term debt at the holding company 
level to enable a resolution that would be smooth in the event 
that such a firm had to be resolved. And we are working with 
those firms also on living wills to enhance their ability to be 
resolved under the Bankruptcy Code.
    Senator Vitter. Thank you, Mr. Chairman.
    Chairman Johnson. Senator Schumer.
    Senator Schumer. Thank you, Mr. Chairman, and thank you, 
Madam Chair. You have done a very good job. You make Brooklyn 
proud, and I am so glad to have these hearings. I have been 
sitting at Humphrey-Hawkins hearings since 1981 in the House 
and Senate, and they are very elucidating.
    So my first question deals with probably your most 
difficult issue as Fed Chair and as a member of the Fed: the 
age-old balancing test between fighting inflation and going to 
full employment. It is a hard tightrope to walk, particularly 
as conditions change, and we are now in a period of change. 
Obviously unemployment has declined, thankfully, and obviously 
the economy is beginning to pick up. And as a result, there is 
a lot of pressure coming from many for you to not only 
accelerate the end of QE2, of quantitative easing, and to raise 
rates.
    I would urge caution very strongly. To me, the greatest 
problem this country still faces is lack of good-paying jobs 
and decline of middle-class incomes. That is with us very, very 
strongly. And worldwide labor markets still keep a lid on 
inflation. Your stated target of 2 percent, 10 years ago if 
people heard the stated target was 2 percent, your 
predecessors, their jaws would drop. But we are not even at 
that.
    So I would just ask you to be very cautious before you 
taper the QE3 program too quickly and entertain the prospect of 
raising rates. Could you comment?
    Ms. Yellen. Yes. I certainly agree and tried to emphasize 
that while we are making progress in the labor market, we have 
not achieved our goal. And it is also the case that inflation 
is running under our 2-percent objective. So both of those 
facts, plus the fact that there have been substantial headwinds 
holding the recovery back and those headwinds, while we are, I 
believe, effectively overcoming them and making progress, until 
they are completely gone, it calls for an accommodative 
monetary policy to offset that. And I would say even if you 
consider our forward guidance we put in place in March, the 
committee indicated that even after we think the time has come 
to raise rates, that we think it will be some considerable time 
before we move them back to historically normal levels. And 
that reflects--well, different people have different views, but 
to my mind, it in part reflects the fact that headwinds holding 
back the recovery do continue. Productivity growth has been 
slow, and, of course, we need to be cautious to make sure the 
economy continues to recover.
    We have tried with respect to our asset purchases to set 
out a clear objective that we had to see a significant 
improvement in the outlook for the labor market and to put in 
place a process by which reductions in the pace of our 
purchases would be measured, deliberate, and allow us time to 
assess how the economy is recovering, and we have followed, I 
think, a very deliberate course.
    As I have also emphasized, this is not a preset course. If 
we were to judge the conditions had changed significantly, it 
is not locked in stone.
    Senator Schumer. Thank you. I am glad and somewhat relieved 
to hear it. I know there are pressures.
    I would like to just tweeze each side of that question as 
my final question. We are seeing improvement in job growth, but 
we are still seeing declines in median income and middle-class 
incomes and lower incomes. And what it means is the number of 
jobs created that really pay well is not growing quickly enough 
and poorer-paying jobs are growing more quickly. How can the 
Fed, if any way, deal with that?
    And on the other side, one of the things you worry about, 
of course, are bubbles, QE3 and others have pushed a lot of 
money into corporate bonds, into the stock market. I do not 
think there are bubbles there yet. But I hope you are 
considering ways to reduce the possibility of bubbles without 
wholesale increases in rates.
    Can you comment on both sides of that?
    Ms. Yellen. With respect to wages, most measures of 
compensation have been running roughly in line with inflation 
so that real gains in compensation adjusted for prices or in 
real terms have been nonexistent. So while rising compensation 
or wage growth is one sign that the labor market is healing, we 
are not even at the point where wages are rising at a pace that 
they could give rise to inflation. In fact, real wages have 
been rising less rapidly than productivity growth, and what we 
have seen is a shift in the distribution of national income 
away from labor and toward capital. So there is some room there 
for faster growth in wages and for real wage gains before we 
need to worry that that is creating overall inflationary 
pressure for the economy. That is something we are watching 
closely.
    With respect to bubbles, I have stated my strong 
preferences to use macroprudential and supervision policies to 
address areas where we see concerns, and as I mentioned, we are 
doing that in the case of, for example, leveraged lending. But 
I would never take off the table totally the idea that monetary 
policy might be needed to address financial stability concerns. 
To me, I do not see financial stability concerns at the level 
at this point where they need to be a key determinant of 
monetary policy. And it is not my preference as a first line of 
defense by any means, but I would never want to take off the 
table that in some circumstances, particularly if 
macroprudential tools failed, monetary policy might be called 
on to play a role. But we are not there.
    Senator Schumer. Thank you.
    Chairman Johnson. Senator Johanns.
    Senator Johanns. Thank you, Mr. Chairman.
    Madam Chair, thank you for being here today. This is the 
third time you have been before the Committee--once as a 
nominee and now twice in your role as Chair. When you came to 
the Committee last fall, I was concerned about the lack of 
progress to deal with the $4 trillion balance sheet. I was then 
and I still am concerned that the risk of quantitative easing 
outweighs the benefits.
    Since that time, I want to say to you I think you have 
moved in the right direction.
    Ms. Yellen. Thank you.
    Senator Johanns. In fact, you have moved at a pace that 
maybe I did not anticipate. You are down to $35 billion per 
month. But the reality is there is still a $4 trillion balance 
sheet out there, which is concerning.
    In your testimony, you speak of your concerns about false 
dawns, and there has been some fits and starts with the Fed in 
terms of tapering.
    So my question gets to this issue: You are anticipating 
that by October this program will cease, come to an end. What 
could happen in that period of time that would cause you to 
recalibrate and decide that October is not the appropriate 
date; maybe the program should go on for a period of time. Tell 
me what metrics you are looking at to make these judgments as 
you go along.
    Ms. Yellen. The committee indicated that the path of 
purchases is not on a preset course, and all along, at each of 
our meetings where we have had to decide whether or not to cut 
the pace of purchases or to stop that or even to increase 
purchases, we have asked ourselves two questions: Is the labor 
market continuing to improve and do we retain confidence that 
going forward it will continue to do so? And do we see evidence 
that inflation is moving and will continue to move back to our 
2-percent objective over time?
    And at every one of our meetings since last December, when 
we started to taper the pace of purchases, we have asked those 
questions, and the answer has been, yes, we think inflation 
stabilized and will gradually move up; and, yes, we think the 
labor market will continue to improve, and we have cut--and we 
use the term ``measured pace'' or $10 billion a meeting. Now 
our forecast is that for the next--that we will continue to see 
those conditions. And I think the evidence we are seeing is 
consistent with that, and if we continue to see progress in the 
labor market, as I expect, and inflation stabilizing or moving 
up toward 2 percent, we would continue on the course we are, 
and as I mentioned, purchases would cease after October. But if 
there were to be some very significant change in the outlook 
that we see between now and October so that we lost confidence 
that the labor market will improve for some reason, or that 
inflation would move back up to 2 percent, then we would have 
to rethink that plan.
    Senator Johanns. Let----
    Ms. Yellen. But that is the plan.
    Senator Johanns. Excuse me. Let me ask you a question--I am 
running out of time here--about the labor market, because I 
think this is a very, very concerning issue for the economy and 
for the country.
    The proportion of Americans in the labor force is now less 
than 63 percent. We have not seen those numbers since Jimmy 
Carter was President many, many years ago.
    I do not know if that is you or me, but it is annoying.
    We have not seen those kinds of numbers since Jimmy Carter 
was President. The Fed has said that you look at the labor 
market. You have just reiterated that in your testimony. 
Originally it seemed like the benchmark you were trying to 
achieve was 6.5 percent. It is now 6.1 percent. But to me, that 
does not tell the story. The fact that our unemployment rate is 
at 6.1 percent does not reflect the reality that really what is 
happening is people are taking part-time work. Whether that is 
Obamacare or some other reason we could debate a long time.
    So tell me what you are looking for when you constantly 
refer to the labor market? Are you looking for more 
participation, more full-time employment? What is it you are 
trying to achieve? And I am going to ask you to be brief 
because I am out of time.
    Ms. Yellen. Briefly, labor force participation certainly 
has moved down. Part of that, I believe, is an aging population 
and demographic. But when we see diminished labor force 
participation among prime-age men and women, that suggests 
something that is not just demographic. And so my personal view 
is that a portion of the decline in labor force participation 
we have seen is a kind of hidden slack or unemployment. It may 
be, if that is correct, that as the labor market strengthens, 
labor force participation will remain flat instead of the 
demographic trend continuing to pull it down, that as people 
who have been discouraged come back into the labor force and 
start looking and getting jobs, we will see the labor force 
participation rate flatten out, and the unemployment rate may 
not come down as quickly as it has been. But we will need to 
look at that. That is a hypothesis.
    I do want to make clear: 6.5 percent has never been our 
objective for the labor force. What we said about 6.5 is that 
we would not--as long as inflation was not a concern, we would 
not think about raising the Federal funds rate above the 0 to 
\1/4\ percent range until unemployment had declined at least 
below 6.5 percent. So that has never been our target, and 6.1 
percent is not our target either. Participants in the FOMC are 
asked what they think a so-called full employment or normal 
longer-run unemployment rate is, and in the Monetary Policy 
Report we distributed in June, they thought that was 5.2 to 5.5 
percent.
    But, of course, we do not know, and we are looking at all 
the things you mentioned in judging the labor force, in judging 
the labor market, not just the unemployment rate but a broad 
range of indicators, including involuntary part-time 
employment, as you mentioned, and broader metrics concerning 
the labor market.
    Senator Johanns. Thank you, Madam Chair.
    Chairman Johnson. Senator Menendez.
    Senator Menendez. Thank you, Mr. Chairman.
    Madam Chair, you were quoted in a New Yorker profile this 
week saying that while the economy is improving from the depths 
of the financial crisis and the Great Recession, ``The 
headwinds are still there.'' And even when the headwinds have 
diminished to the point where the economy is finally back on 
track and it is where we want it to be, ``It is still going to 
require an unusually accommodative monetary policy.'' That was 
your statement.
    That seems pretty consistent with the concern of prominent 
economists outside of the Fed, that current economic conditions 
and fiscal policy are producing an environment that requires 
low than normal interest rates to generate economic growth and 
create jobs.
    Can you explain to me what you mean about the need for 
``unusually accommodative monetary policy''? And do you agree 
with the views being discussed by many, Larry Summers and 
others, about lower than normal interest rates and the dangers 
of tightening too soon?
    Ms. Yellen. I do agree with the view that there are 
substantial headwinds facing the economy. One example would be 
that we see in surveys of households that their expectations 
about their future finances and growth in their real incomes 
are exceptionally depressed. And I think that is a factor that 
is depressing spending.
    We see in the housing market, where we had some progress 
but it now looks like it is stalled, a lack of credit 
availability for anyone who has anything other than a pristine 
credit rating I think remains a factor, and that is in many 
ways and complicated ways a legacy of what we have lived 
through.
    So I think there are--and fiscal policy has been a factor, 
in my view holding back the recovery. And that is what monetary 
policy has had to counteract, and that is in part why we have 
needed such an accommodative monetary policy for so long.
    Now, the economy is making progress. I do believe it is 
making progress, and eventually, if we continue, a day will 
come when I think it will be appropriate to begin to raise our 
target for the Federal funds rate. But to the extent that even 
when the economy gets back on track, it does not mean that 
these headwinds will have completely disappeared. And in 
addition to that, productivity growth is rather low. At least 
that may not be a permanent state of affairs, but it is 
certainly something that we have seen in the aftermath--well, 
we have seen it during most of the recovery. That is a factor 
that I think is suppressing business investment and will work 
for some time to hold interest rates down.
    These concerns and these factors are related to what 
economists are discussing, including secular stagnation. The 
committee, when it thinks about what is normal in the longer 
run, the committee has recently slightly reduced their 
estimates of what will be normal in the longer run. The median 
view on that is now something around the 3\3/4\ percent. But we 
do not really know. But it is the same factors that are making 
the committee feel that it will be appropriate to raise rates 
only gradually, they are some of the same factors that figure 
in the secular stagnation.
    Senator Menendez. Let me ask you beyond what the Fed is 
doing. Are there fiscal policy steps the Congress can take to 
improve the situation and reduce the headwinds against growth? 
For example, we have interest rates at near historic lows and 
construction employment is still below the precrisis levels. 
For example, would it not be time to invest in repairing our 
Nation's transportation and other infrastructure as a way to 
help against such headwinds?
    Ms. Yellen. As I have said, fiscal policy for a number of 
years has been a drag on growth, and that is, we can translate 
that into a factor that has necessitated lower than normal 
interest rates to get the economy moving back on track. And, of 
course, it is a judgment for Congress what the appropriate 
priorities are, but I would certainly say that fiscal policy 
has been unusually tight for a period like we have lived 
through.
    Senator Menendez. I understand that you do not want to 
dictate what Congress' priorities are, but if, in fact, 
Congress were to say, well, investing significantly, robustly 
in our transportation infrastructure and other similar 
infrastructure projects, would that be something that would 
help against the headwinds?
    Ms. Yellen. Well, certainly it would be a counter to those 
headwinds, yes.
    Senator Menendez. Thank you.
    Chairman Johnson. Senator Heller.
    Senator Heller. Thank you, Mr. Chairman, and thank you for 
holding this particular hearing.
    Chairman, thank you for being here. I apologize. I have not 
been here for all the questioning. The Ranking Member and 
myself are running back and forth to the Energy Committee 
talking about fire suppression. I know you get a lot of credit 
and blame. I want you to know I am not blaming you for the 
fires out West, all right? So we can take that question off the 
table. I know you do take a lot of credit and a lot of blame, 
and I just want to thank you for taking time.
    You said in your opening remarks that the recovery is not 
complete from the Great Recession. And we have had a lot of 
lively debates here in this Committee over the soundness and 
the safety of our market structures. We even had a hearing last 
week on high-frequency trading. Some are going so far to claim 
that markets perhaps are rigged. If you talked to individuals 5 
years ago, in 2008, and told them we were going to go 5 years 
through a Great Recession and in that 5-year period you are 
going to see the stock market go from 6,500 to 17,000, not too 
many people would have believed that.
    So I guess the question is: Books are being written about 
this. Individuals are now going as far as to claim the markets 
are rigged. I want to get your feelings on this. Do you believe 
the stock markets are rigged?
    Ms. Yellen. I think there are a number of concerns that 
have been outlined about high-frequency trading, and I believe 
it was in June Mary Jo White, the Chair of the SEC, gave a very 
important and very detailed discussion of high-frequency 
trading, outlining where she saw problems and what potential 
solutions might be to those problems.
    Senator Heller. The quantitative easing, do you believe 
that unintended consequences of QE1, 2, and 3 may be with all 
the bond buying, that it is forcing people into the stock 
markets, creating this bubble?
    Ms. Yellen. I think an environment of low interest rates in 
general, which have been promoted by both our keeping the 
Federal funds rate at 0 and additionally by our purchases, low 
rates do have an incentive to push individuals to look for 
yield, to reach for yield. And that is both a good thing and a 
bad thing.
    On the one hand, we need healthy risk taking in order to 
spur our recovery. And low interest rates I think have had a 
positive effect on helping the recovery. But, of course, we 
have to be careful about looking for situations where low rates 
may be incenting behavior that can be dangerous to financial 
stability. And I particularly outlined in my remarks an area 
like leveraged lending where we are seeing a marked 
deterioration in underwriting standards, and it looks like it 
may be part of a reach for yield, and we are trying to deal 
with that through supervisory means.
    But the kind of broad-based increase in leverage in the 
economy and maturity transformation and credit growth that one 
tends to see in a situation where there are intense financial 
stability risks, I do not think we see those things. So at this 
point they are more isolated and not broad-based in general, at 
least in my assessment.
    Senator Heller. Thank you, Dr. Yellen.
    I will go back to Senator Johanns' questions on 
quantitative easing. I may ask it just a little bit 
differently, but you do see a time when the Federal Reserve 
stops the bond-buying program?
    Ms. Yellen. As I indicated in my opening remarks, if things 
continue on the current course, as the committee expects, the 
purchases would cease after our October meeting.
    Senator Heller. So if they cease, do you see--I guess my 
question today would be: Would you ever see the restarting of 
quantitative easing? In other words, once it ends, do you 
believe that this is now the new normal, the Federal Government 
buys these bonds? Or would you commit to saying that 
quantitative easing has come and gone and we have seen the last 
of it?
    Ms. Yellen. It really depends on what the economy does. The 
economic outlook is very uncertain. I hope we are on a solid 
course of recovery and that it will continue and not encounter 
some serious setback.
    I would not take it off the table forever as a tool the 
Federal Reserve might need to someday in some circumstances use 
again. But my hope is we are on a path of recovery and monetary 
policy will over time normalize, that our purchases will end, 
eventually our balance sheet will begin to shrink back toward 
more normal size, and when the time is right, that short-term 
interest rates will begin to move above their current very, 
very low levels, too.
    Senator Heller. Dr. Yellen, thank you.
    Mr. Chairman, thank you.
    Chairman Johnson. Senator Brown.
    Senator Brown. Thank you, Mr. Chairman. Madam Chair, thank 
you for being here.
    These hearings so often focus on when the Fed will change 
its policies so financial markets will rally and Wall Street 
lenders can make money. Too often we forget about the human 
side of these issues. As Federal Reserve Chair, you have worked 
to put a face on economic numbers. We are appreciative of that. 
Last February, you spoke of the toll on unemployed workers 
``being simply terrible on the mental and physical health of 
workers, on their marriages, on their children.''
    It seems, though, Madam Chair, too many people around here 
still view unemployed workers as lazy, as shiftless people who 
do not really want to work. And so we simply don't extend 
programs like unemployment insurance.
    Talk for a minute or two about the psychological effects 
that unemployment has on workers, why the psychology is so 
important, why it should matter to all of us, even a Senator 
who goes to work in a suit every day and speaks with an upper-
class accent.
    Ms. Yellen. I think many workers who lose jobs that they 
are attached to and depend on for their livelihoods experience 
exceptional psychological trauma when they become unemployed, 
and especially when the unemployment is of long duration, as it 
has been for so many individuals who find themselves unemployed 
now.
    First of all, there is a very significant loss in lifetime 
income. Many studies have documented for workers who experience 
job loss when unemployment is as high as it has been and they 
find it difficult to get another job. And, of course, there is 
the fear that goes with that of, ``How will I support my 
family? How will I take care of my children?'' I gave a speech 
in Chicago in February and talked to a number of unemployed 
workers, and I heard personal stories about individuals who 
were supporting children and concerned that because in some 
cases they could only find part-time, low-paying jobs, that 
they could not continue to support their children adequately.
    And there are a number of studies when I use those words, 
that it takes such a toll on families and children and 
psychologically, that is based on a number of studies that have 
documented that, that there are health costs to workers who 
lose their jobs, that in terms of the progress of their 
children that there are losses to their children when a parent 
loses a job for a significant amount of time, and in terms of 
the odds of divorce and breakup of a family, that is obviously 
present, too.
    And for people their jobs are often their identities, and 
when an individual cannot find a job for a prolonged period of 
time, ``Who am I and what is my role? And how do I contribute 
to my community and to my family?'' become a real psychological 
toll. I think anyone who has ever talked to people experiencing 
significant unemployment realizes what the psychological toll 
is and the ways it affects their well-being and that of their 
community.
    Senator Brown. Thank you for realizing that that is an 
important part of your job, to continue to forcefully speak out 
about the human side and the human cost of economic policies.
    Let me shift to another question. Too many Americans look 
at Washington's response to the financial crisis and feel that 
nothing has changed. After all, the four largest banks are 25 
percent larger than they were in 2007. Federal Reserve Vice 
Chair Stanley Fischer said last week, ``What about simply 
breaking up the largest financial institutions? While there is 
no simply,'' he points out in this area, ``actively breaking up 
the largest banks would be a very complex task with uncertain 
payoff.''
    It is troubling to me that the largest banks are so complex 
that one of our Nation's top regulators cannot understand these 
institutions, particularly since he worked at one of them. But 
Dr. Fischer's view reflects years-old sentiment expressed by 
Governor Dan Tarullo in 2009 that ``Break up the banks'' is 
more of a slogan, Governor Tarullo said, than a serious policy 
proposal. But Governor Tarullo's views evolved. Last year, he 
praised a plan that I worked on with Senator Kaufman from 
Delaware, who has since left the Senate, to cap a bank's 
nondeposit liabilities at 3 percent of U.S. GDP.
    My question is: Do you agree with Vice Chair Fischer or do 
you agree with Governor Tarullo?
    Ms. Yellen. I think one of the things that Vice Chair 
Fischer said that I certainly agree with is that systemic risk 
in the financial system is not purely a question of too-big-to-
fail institutions. And we should not lull ourselves into 
thinking that if we deal with ways to resolve or diminish the 
role of those institutions that systemic risk is not still a 
real phenomenon that we have to worry about.
    During the Great Depression, when we had a financial 
crisis, it was mainly a large number of small banks that were 
affected, and then we saw runs on the banking system that had 
the potential to and did cause a collapse of credit in the 
economy. So I think he pointed out, and I agree, that we have 
to worry about more than the too-big-to-fail firms, and we 
could have systemic risk if a large number of smaller 
institutions are hit for some reason.
    But it is certainly, I agree with my colleague Governor 
Tarullo, we are completely committed to trying to deal with too 
big to fail, and we have put in place numerous steps and have 
more in the works that will strengthen these institutions, 
force them to hold a great deal of additional capital, and 
reduce their odds of failure. And then on top of that, if they 
do fail, it is important that we be able to resolve these 
firms, and we are also working on having the ability to do 
that.
    So, on the one hand, there will be much lower odds that a 
so-called systemic firm would fail, and should that occur, we 
will have better tools to be able to deal with it. And through 
the living will process and through other aspects of our 
supervision, we are trying to give these firms feedback on ways 
in which they can alter their structure in order to enhance 
their resolvability.
    Senator Brown. I think the important point you made was 
during the living will process, for these 11 largest firms, 
that the issue of complex--that we really cannot address the 
issues of complexity, you and the FDIC. So thank you, Madam 
Chair.
    Chairman Johnson. Senator Toomey.
    Senator Toomey. Thank you, Mr. Chairman. And thank you, 
Madam Chair, for joining us yet again.
    I think you know from our previous conversations I have 
long been of the view that the risks associated with this 
unprecedented experiment in monetary policy probably outweigh 
the meager benefits. So I disclose that up front.
    But I want to understand better a different aspect of this, 
and that is, a movement toward normalization, which, arguably, 
is underway now, necessarily depends on the projections that 
the Fed makes. You have discussed some of those inflation 
projections, unemployment projections, GDP projections.
    What concerns me is that these things are very hard to 
project, and the Fed does not have a great track record in 
projecting these things. I do not think the Fed really 
anticipated, for instance, the extent to which a decline in the 
workforce participation would drive unemployment rates lower.
    I have a little graph here, which I know you cannot see 
from where you are, but, Mr. Chairman, I will ask that it be 
included in the record.
    It simply depicts the Fed's projection of GDP 1 year out, 
and then compares that to where GDP actually was, and it has 
been pretty terrible wrong for 10 years. It seems as though 
there is a systemic bias with a more optimistic outlook than 
what has actually come to pass.
    So my question is: To what extent--how introspective is the 
Fed being about their own limitations in making projections 
which ultimately are driving a movement in the direction of 
normalization? And maybe more precisely, do Fed members 
incorporate into your own decision-making process the fact that 
these projections have not been so good? And that is not to say 
you are unique in getting these projections wrong. I understand 
how difficult they are. But don't they argue for a more 
conservative approach and a quicker move to normalization since 
you know that very frequently these projections have been 
wrong?
    Ms. Yellen. I certainly agree that projecting future 
economic activity is a very difficult business, and our GDP 
projections have been for a number of years too optimistic. I 
would say that our projections about the labor market and 
unemployment as well as inflation have come closer to the mark. 
So GDP stands out as someplace where our projections have been 
systematically off.
    And, of course, we have to gear monetary policy to what 
actually occurs in the economy, and not just what we expect 
will happen in the future to the economy. So our forward 
guidance, for example, is very explicit in saying that the time 
of normalization of policy, the time at which we would begin to 
raise the Federal funds rate above the 0 to \1/4\ percent range 
will depend on both actual progress, which we can see that is 
not a forecast, and our expectations about future progress in 
achieving both of those goals.
    So we are looking at what happens in the economy, and when 
we are wrong, we take that into account. And as we see 
ourselves coming closer to our goals or failing to achieve our 
goals, that is real live data that we respond to and adjust our 
policy accordingly. And I think that must be a feature of 
monetary policy, is that it adjusts to actually unfolding 
events and not just what we expected.
    Senator Toomey. Thank you. One other question. You know 
there is often a lot of discussion about the Fed following some 
kind of well-defined rule, and obviously many central banks do 
that. The Fed itself has done it in the past.
    What is your reaction to the idea that the Fed would be 
able to design its own rule, but it would be an objective, 
data-driven rule, the Fed would be required to disclose the 
rule, and the Fed would be allowed to deviate from the rule, 
but it would have to come to Congress and explain when and why 
it was doing so? What are your thoughts on an arrangement of 
that nature?
    Ms. Yellen. No central bank in the world follows a 
mechanical mathematical rule, and I think it would be a 
terrible mistake to ask the Federal Reserve to specify a 
mathematical rule----
    Senator Toomey. Well, we have got central banks that peg 
their currency. I mean, that is pretty much a well-defined 
rule.
    Ms. Yellen. Or a currency board.
    Senator Toomey. Or having a gold standard is a pretty well-
defined rule. So historically it has not been uncommon.
    Ms. Yellen. OK. So if that is what you mean by your rule of 
gold standard or currency board, yes, that has happened. But 
given the goals that Congress has assigned to us with respect 
to inflation and employment, I am not aware of any, for 
example, inflation-targeting country, of which there are many, 
that has a mathematical rule.
    Nevertheless, it makes perfect sense to behave in a 
relatively systematic way, looking, when you have objectives, 
asking the question how far are you from achieving those 
objectives, and how fast do you expect progress to be made in 
determining whether or not--exactly how much accommodation is 
needed. And a number of different factors come into play at 
different times. If we were following a specific mathematical 
rule, I really think performance in this recovery would have 
been dreadful. Most of the rules we would have used, first of 
all, we could have not followed in the depths of the downturn. 
They would have called for negative interest rates. And if we 
had tightened monetary policies, some of those rules would have 
called for--given the headwinds we face, the recovery would not 
be as far advanced as it is.
    So there are special factors and structural changes that 
need to be taken into account that would make me very 
disinclined to follow a mathematical rule. But I think it is 
important that the central bank behave in a systematic and 
predictable way and to explain what it is doing and how it sees 
itself as likely to respond to future economic developments as 
they unfold, and that is precisely what we are trying to do 
with our forward guidance.
    Senator Toomey. Thank you, Madam Chair.
    Chairman Johnson. Senator Tester.
    Senator Tester. Yes, thank you, Mr. Chairman, and thank 
you, Chairman Yellen, for the work that you have done.
    I think in previous sessions that we have had, I think you 
have agreed that the FSOC and the Fed have and should exercise 
their authority to develop industry-specific guidelines and 
metrics rather than forcing insurers or asset management firms 
into a bank-centric regulatory model. I mean, that is still 
your position, I would assume?
    Ms. Yellen. I believe with respect to designation that each 
unique company that is under consideration needs to be 
carefully----
    Senator Tester. Good.
    Ms. Yellen. ----evaluated in detail.
    Senator Tester. OK. Thank you. In the past, some of us on 
this Committee have raised concerns that the FSOC seems to have 
a lack of transparency in the SIFI designation process. Could 
you give me your views as far as whether the process should be 
transparent or not? Or maybe I should word it this way: Can you 
tell me why the process should not be transparent if you think 
it should not be transparent?
    Ms. Yellen. I think that it should be transparent what it 
is that the FSOC is considering and looking for and trying to 
evaluate when it evaluates any particular firm. And I believe 
the FSOC has made it clear that they are trying to identify 
entities that are responsible for systemic risk to the 
financial system and the metrics that it looks to to evaluate 
that.
    But there is a great deal of confidential firm-specific 
information that comes into play in evaluating a particular 
firm that I do not think should be in the public domain----
    Senator Tester. I have got----
    Ms. Yellen. ----unless it is actually designated, in which 
case it has been brought into the public domain.
    Senator Tester. Right. But you do believe the metrics 
should be transparent?
    Ms. Yellen. Well, the criteria that we use to establish--to 
designate should be clear.
    Senator Tester. Do you believe they are now?
    Ms. Yellen. I believe they are reasonably clear.
    Senator Tester. OK, because there are some--well, there are 
some, and I am one of them, that believe the process has not 
been transparent at all. And what I would ask of you, because I 
believe you think it should be--and I agree with you. The 
information that is specific to a company does not need to be 
transparent, but I think the metrics they are using, so we know 
what they are looking for, so that, quite frankly, everybody 
knows what they are looking for when it comes to designation is 
important.
    Ms. Yellen. Right, and I believe they have indicated what 
kinds of things they are taking into account.
    Senator Tester. About 6 months ago, when you were before 
this Committee, we talked about clarifying the end user 
exemption from the margin that was included in the Dodd-Frank, 
given the minimal risk that they pose in the overall market. 
You and former Chairman Bernanke and Governor Tarullo all 
indicated comfort with exempting end users from the costly 
margin requirements. Is this still true today? Do you still 
feel this way?
    Ms. Yellen. Yes.
    Senator Tester. Good. You had indicated that the rule would 
be out by the end of the year, the end-user rule. I am just 
wondering if you are still on schedule.
    Ms. Yellen. I think that is correct that we are.
    Senator Tester. A few more head nods. OK. That is very, 
very good. Thank you very much for that.
    I want to talk a little bit about the assessment just to 
give me an idea--and I may have asked this question before, and 
if I have, forgive me. When you are looking at the assessment 
of incoming information when it comes to the economy and when 
it comes to the Fed funds, the labor market is one of them. GDP 
is one of them. I would assume housing is one of them. What are 
some other indicators you are looking at?
    Ms. Yellen. We are really trying to assess the likely path 
of the labor market and employment and inflation, which are the 
two goals Congress told us to focus on. But in trying to make 
those assessments, we have to look at a huge range of data: 
housing, consumer spending, the strength of investment 
spending, what is happening in the global economy, what do we 
expect will happen to our exports and imports. All of that 
figures into what will growth be in the economy, and then in 
turn, matters like productivity growth will affect how that 
translates into progress in the labor market. And with respect 
to inflation, of course, we are looking at many different 
metrics.
    Senator Tester. And of all those things you listed, which 
is of the most concern?
    Ms. Yellen. Of all of those different metrics?
    Senator Tester. Yes. You were talking about the inputs that 
you consider within the economy. What is of the most concern?
    Ms. Yellen. At this moment?
    Senator Tester. Yes,
    Ms. Yellen. What is of the most concern?
    Senator Tester. Yes.
    Ms. Yellen. I mean, essentially the committee, having 
looked at all of these different factors, holds the view that 
we will enjoy moderate growth for the rest of the year and for 
the next couple of years, and the labor market will improve. 
And so while we are concerned that housing is a sector where we 
expected to see better recovery. We are not, that is a concern. 
But it is not quantitatively important enough to cause us to 
judge that it will hold back the recovery.
    Senator Tester. Thank you.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Coburn.
    Senator Coburn. Thank you, Madam Chairman, for being here. 
I appreciate your work and your interest.
    You gave a speech recently on the importance of 
macroprudential tools to curtail financial instability if a 
particular asset class gets overheated. The persistent low 
interest rate environment has caused a reach for yield. The Fed 
is taking the stance that regulatory tools such as increased 
capital requirements, countercyclical buffers, margining, 
central clearing, requirements for derivatives will improve the 
resiliency of our financial system.
    So my question for you: Rather than preventing asset 
bubbles from happening, we are now taking the approach that 
they are going to happen and we are going to deal with them. Is 
that an accurate statement?
    Ms. Yellen. I think the steps that you indicated to 
strengthen the financial system do two things.
    They diminish the odds that bubbles will develop. For 
example, these rules diminish the chance that leverage will 
buildup as an economy strengthens. We have taken steps and will 
take further steps to diminish the likely buildup in leverage 
in the economy, so----
    Senator Coburn. But you would agree that zero interest rate 
policy is tending to make people reach for yield now and is an 
impetus toward bubble creation in certain asset classes?
    Ms. Yellen. It can be, and that is why we are watching very 
carefully, but----
    Senator Coburn. Is there any one particular area that you 
are worried about right now in terms of asset bubbles?
    Ms. Yellen. I have mentioned leverage lending and corporate 
debt markets, especially lower-rated companies. I think we are 
seeing a deterioration in lending standards. And we are 
attentive to risks that can develop in this environment, for 
example, that banks may be or others may be taking on interest 
rate risk, and when interest rates ultimately begin to rise, 
that if firms or individuals have taken risks and are not 
adequately prepared to deal with them, that can cause distress.
    Among the institutions that we supervise, we are certainly 
looking at management of interest rate risk. We are using 
stress testing, and in this latest round, we had specific 
scenarios designed to look at how large banking organizations 
would fare if interest rates were to increase rapidly. And we 
are focused on how firms are managing their own interest rate 
risk.
    So I think there are some risks in a low interest rate 
environment. I have indicated that, and we are aware of them. 
But I think the improvements we have put in place in terms of 
regulation both diminishes the odds that risk will develop and, 
if there is an asset bubble and it bursts, it will--and we are 
not going to be able to catch every asset bubble or everything 
that develops----
    Senator Coburn. I guess that goes to my core question. 
Rather than have a policy that causes bubbles to create, why 
wouldn't we have a policy that does not cause that, one? And, 
number two, it just seems to me now that we are kind of locked 
in this zero interest rate phenomenon, and one of the 
consequences of that is reaching for yield, and now we are 
going to try to attenuate the response to the zero interest 
rate rather than change the zero interest rate policy so that 
we do not have the bubbles in the first place.
    Ms. Yellen. We have to recognize also that we are dealing 
with a real problem. The reason we have low interest rates is 
to deal with a very real problem, namely, the economy is 
operating significantly short of its potential, employment is 
suppressed well below its maximum sustainable level, and 
inflation is running below our objectives. That is why we are 
holding interest rates low, and were we to significantly raise 
interest rates to deal with a set of concerns that you 
indicated, we should expect even worse performance on those 
important goals that Congress has established for the Federal 
Reserve. And if we were to weaken the economy, it is not even 
clear that we would be mitigating financial stability risks 
overall, because----
    Senator Coburn. We are in the trap.
    Ms. Yellen. There are considerations in both directions, 
and so we need to be very attentive to the financial stability 
risks. And as I have indicated, if they were to become extreme 
and other tools were not available or were not successful, I 
would not take monetary policy off the table as a tool to be 
used. But we should by no means think that it would be costless 
because it could be very costly in terms of achieving other 
very important objectives, and a weak economy creates its own 
set of financial stability risks. So it is not even clear that 
on balance we would be promoting financial stability.
    So this is not a simple matter. There are complex tradeoffs 
involved here.
    Senator Coburn. Mr. Chairman, I have additional questions 
for the record.
    Chairman Johnson. Yes.
    Senator Coburn. Thank you.
    Chairman Johnson. The Chair notes that we have five Members 
and less than 20 minutes remaining to devote.
    Senator Warner.
    Senator Warner. Thank you, Mr. Chairman, and thank you, 
Chairman Yellen, for your good work. I will try to make my 
questions quick and make one front-end comment.
    As someone who advocated very strongly during Dodd-Frank 
that nonbanks could be SIFIs, I have to tell you I share 
Senator Tester's concern about the transparency as we go 
through this process. We have got to get it right, and my 
concern is that for the nonbank SIFI designation, there is 
still a great question on transparency about whether it is size 
or product component, and the more clarity we can get on this, 
the better.
    There are two questions I want to get at. One is an issue 
that has not been raised yet. I know some of us on this side of 
the aisle have grave concerns around student debt. At $1.1 
trillion now, it is greater than credit card debt. I personally 
believe it is retarding recovery in the housing industry. It is 
clearly retarding the growth in the number of entrepreneurs. 
Some of us have proposed refinancing proposals. We have looked 
at income-based repayment plans. There is a bipartisan 
opportunity out there that would allow an employer to take a 
portion of an employee's salary and apply it directly to the 
student debt pretax, the same way we already allow for tuition.
    But is this a subject that at the Fed you have looked at 
and want to make a comment on in terms of this rising potential 
bubble in student debt and its effect on the economy?
    Ms. Yellen. We certainly are looking at it, and the growth 
in student debt has been really dramatic. I think there has 
been some work that documents that it is probably having an 
effect on the ability of young people to purchase homes. And it 
certainly is a burden for those individuals that they will be 
carrying through their lives.
    On the other hand, education is extremely important, and 
making available the financing that is necessary in this 
economy for individuals to acquire an education is of the first 
order of importance. I would be concerned, of course, that some 
of the decisions that students are making, they may not fully 
understand the burdens that they are assuming and how they will 
affect their lives. And, second of all, they may not be always 
accurately evaluating what the payoffs are to the training that 
they are taking on, and especially when there is inadequate 
information about the performance of the schools or programs 
that they are enrolled in, what are the job-finding and income 
prospects, and----
    Senator Warner. We have actually some bipartisan 
legislation that we ought to have a user-friendly Web site for 
all institutions, the same way we have got in housing and 
elsewhere, a Zillow-type site for students. And so know before 
you go is the approach we have. But I would point out that, you 
know, we have seen student debt quadruple from about $200 
billion----
    Ms. Yellen. It is very----
    Senator Warner. ----to well north of--$240 billion in 2003 
to $1.1 trillion roughly now. I would urge you and even at the 
FSOC level to look at this, and if you have got some additional 
suggestions.
    I want to use my last moment to get in a question that I 
have asked before, but I want to prod you one more time, and 
that is on excess reserves. And when we were last--before, you 
kind of gave me the same answer that Chairman Bernanke gave, 
and the concern that if you kind of got rid of some of these 
excess reserves, which, you know, you are currently paying 25 
basis points, and the excess reserves that have gone from $2.4 
trillion to close to $2.6 trillion. The European Central Bank 
has actually got a negative 10 basis points on their policy 
toward these excess reserves. I realize your concerns, the 
effect it might have on money market funds, but with money 
market fund rates already so low, I still just do not 
understand why reexamining this policy might push some of our 
financial institutions to actually be willing to do a little 
more lending rather than to house these funds at the Fed.
    Ms. Yellen. It is a very legitimate question, and it is 
something that we have considered and debated, and there have 
been mixed views in the committee on the desirability of doing 
that. We have been quite concerned about what it might mean, 
given the structure of our money markets, for money----
    Senator Warner. Money market funds are already pretty low 
at this point.
    Ms. Yellen. Yeah. We have----
    Senator Warner. But my hope would be that you continue that 
debate, or at least this Member believes that this could be 
something that could be stimulative to the economy and get 
these banks taking this capital away from the Fed and actually 
into the economy. Thank you, Madam Chair.
    Chairman Johnson. Senator Merkley.
    Senator Merkley. Thank you very much, Mr. Chair. And thank 
you for your testimony today.
    I will try to be very crisp in these questions, given the 
time. But insurance advocates have expressed concerns that new 
regulations might be forthcoming based on an international 
standard influenced by Nations that do not have our State 
guarantee system, and they believe that this may result in new 
capital requirements that are unnecessary and inappropriate for 
the structure of the industry in our Nation.
    Are there any thoughts that you might have to share on that 
particular topic?
    Ms. Yellen. I would simply say that the Federal Reserve is 
participating now in an international association of insurance 
supervisors discussing for internationally active insurance 
firms what might be appropriate capital standards for groups, 
you know, for essentially consolidated capital requirements 
for--not legal entity insurance firms that are regulated by the 
States--but the consolidated holding companies. Nothing that 
happens in that context--it is similar to our participation in 
the Basel Committee. We are looking to put in place appropriate 
standards here in the United States, and nothing that is 
decided in that international group has any force in the United 
States unless we propose rules, put them out for comment, and 
finalize them.
    But I think it is helpful to get the perspectives of others 
and, to the extent possible and appropriate, to have an 
internationally level playing field.
    Senator Merkley. Thank you. I am going to jump right into 
the next point, which I wanted to double down on the student 
loan question, because I feel like there is a huge amount of 
emerging information about the delay in home acquisition, and 
this is certainly a drag in itself on our economy as well as an 
impact on the quality of life of our young folks. But it also 
has a significant extended effect through the decades to come 
because of the slow pace of wealth aggregation for families if 
they do not engage in home ownership earlier on. And it is 
actually shocking to see a reverse of a key statistic in which 
folks who are 25 to 30 who have gone to college are now less 
likely to own a home than folks who did not go to college. So I 
just want to encourage--this issue really goes to the heart of 
the American dream because the cost of college is not only 
affecting those who went and have this debt, but it is 
affecting the aspirations of our children in high school who 
are starting to get advice, particularly in blue-collar 
communities like the one I live in, that maybe you should not 
risk carrying this mountain of debt in the context of such high 
uncertainty over jobs that might be able to have a monthly wage 
that could make those payments.
    Ms. Yellen. I agree with you that when you look at the 
numbers on student debt, it has to be a significant concern for 
just the reasons you gave.
    Senator Merkley. Thank you. I will look forward to any work 
that the Fed is doing in this area to understand better the 
impacts on the economy.
    I want to turn to the financial reform rulemaking process, 
and I know you have expressed concern with the frustratingly 
slow pace of some of the rulemaking, and we have still got 
quite a long list from Dodd-Frank here 4 years later that has 
not been completed on credit rating agencies, conflict of 
interest, and securitization are the issues that Senator Levin 
was so forceful in bringing forward during Dodd-Frank, 
security-based swaps, compensation structures, and so forth.
    Do we have kind of a crisis of confidence in our ability to 
make the rulemaking system function? When we have in a law a 
goal for a rule and sometimes it is a year, sometimes it is 2 
years, and we just cannot seem to get the rules completed and 
maybe even end up in Never, Never Land, appropriately named 
because it seems like we are never going to get to final rules, 
is this a change from two decades ago? What do we do about it?
    Ms. Yellen. I know it has been frustratingly slow. It is 
complicated, and we want to take the time to get it right. We 
are involved in a lot of rulemakings that involve multiple 
agencies with different perspectives, and we are also trying to 
coordinate with other countries to move forward together so we 
maintain in many areas a level playing field, and this is 
immensely time-consuming work.
    I understand your frustration. I guess I see a bunch of 
rules in the pipeline that I hope will be completed in the not 
too distant future--the liquidity coverage ratio, QRM, other 
things that we can expect to come out of the pipeline. And I 
see a further agenda of rules that I really hope we will make a 
great deal of progress on this year.
    So to me, the glass is more half full than half empty, and 
I actually believe we have made substantial progress and will 
continue to push forward.
    Senator Merkley. Thank you,
    Chairman Johnson. Senator Hagan.
    Senator Hagan. Thank you, Mr. Chairman. And, Chairman 
Yellen, thank you for your service and for being here today.
    I wanted to follow up on a letter that I sent to the 
Federal Reserve, the OCC, and the FDIC, and it is regarding the 
liquidity coverage ratio standard. I have heard a number of 
concerns from communities in North Carolina about the exclusion 
of the municipal securities from the high-quality liquid assets 
designation, and in particular, I am concerned that this 
exclusion of the municipal securities could restrict the 
ability of State and local governments to raise the capital 
that they need to finance these public investments in schools 
and hospitals and roads and airports, and then all the other 
infrastructure systems. And these projects are really the 
cornerstone of the U.S. economy.
    What is the justification for excluding these municipal 
securities when other types of debt, including foreign 
sovereign debt, are covered? It seems like a strange outcome to 
me for the debt of some foreign countries to be treated more 
favorably than the AAA-rated debt of States like North 
Carolina.
    Ms. Yellen. So let me say this is a proposal we have put 
out for comment, and we will look very carefully at the 
comments we receive on this and other topics.
    The rationale for excluding them is that we are expecting 
firms to hold truly high-quality liquid assets, and the 
liquidity of municipal bonds is substantially lower than any of 
the assets that are included on that list. So the absence of 
liquid markets where those securities are traded was the reason 
for excluding them, but we will be looking very carefully at 
comments before we come out with a final proposal.
    Senator Hagan. Well, I ask that you consider the impact 
that this exclusion could have on infrastructure investments 
and then the ability of the States and local governments to 
actually manage their debt.
    Ms. Yellen. We will look at those comments.
    Senator Hagan. Thank you. And I also wanted to follow up on 
Senator Merkley's question concerning the new global standards 
for the insurance entities. I believe it is important that the 
insurance companies be protected and that the State model for 
regulating the insurance also be respected. And as a member of 
the Financial Stability Board and a participant in these 
meetings, can you explain in a little bit more detail what the 
Federal Reserve is doing to ensure that any international 
regulations do not harm these companies and respect the State-
based model of the insurance regulation?
    Ms. Yellen. We are working very closely and the State 
regulators are participating in these international discussions 
as well. Nothing that is under consideration would affect the 
way in which legal entity insurance companies are regulated 
with respect to capital by the States. So we are looking at a 
separate set of capital requirements that would apply to the 
consolidated organization. And, again, nothing that happens in 
this international forum has any effect on American firms until 
we have incorporated them into regulations which go out for 
comment and are ultimately finalized.
    Senator Hagan. Thank you.
    Thank you, Mr. Chairman.
    Chairman Johnson. Senator Warren.
    Senator Warren. Thank you, Mr. Chairman. And thank you, 
Chair Yellen, for being here today.
    You know, one of the tools that Congress has given the Fed 
to combat too big to fail is Section 165 of Dodd-Frank. This is 
the section that requires large financial institutions to 
submit plans each year describing how they could be liquidated 
in a rapid and orderly fashion without bringing down the entire 
economy or needing a taxpayer bailout.
    Now, the Fed and the FDIC must review these plans, and if 
they do not buy that the plan would actually result in the 
rapid and orderly liquidation of the company, then they must 
order the company to submit a new plan. And here is the key 
part. As part of the order to submit a new plan, the Fed and 
the FDIC can require the company to simplify its structure or 
sell off some of its assets--in other words, break up the bank 
so that it could be more easily liquidated and not pose a risk 
to the economy.
    So let us consider what happened during the Lehman Brothers 
bankruptcy in 2008. That is the one that sparked the financial 
crisis, nearly melted down the economy, and triggered the 
bailout by the taxpayers. The court proceedings took 3 years, 
clearly not rapid or orderly. But Lehman was tiny compared to 
today's biggest banks. When it failed, Lehman had $639 billion 
in assets. Today JPMorgan has nearly $2.5 trillion in assets. 
That is 4 times as big as Lehman was when it failed.
    Lehman had 209 registered subsidiaries when it failed. 
JPMorgan--I really almost could not believe this when I read 
it. JPMorgan today has 3,391 subsidiaries. That is more than 15 
times the number of subsidiaries that Lehman had when it 
failed. Three years to resolve Lehman.
    Now, JPMorgan has filed resolution plans in each of the 
last 3 years, and the Fed has not rejected any of them as not 
credible. Given our recent experience with the bankruptcy of 
Lehman Brothers, can you honestly say that JPMorgan could be 
resolved in a rapid and orderly fashion, as described in its 
plans, with no threats to the economy and no need for a 
taxpayer bailout?
    Ms. Yellen. The living will process, as I understand it, is 
something that is intended to be iterative in the sense that 
the firms submit plans and will receive feedback from the 
regulators on whether or not we think the Fed and the FDIC 
regard these plans as sufficient to enable resolution under the 
Bankruptcy Code.
    We have given feedback on the first round of plans that 
were submitted and are working actually at this point to give 
feedback on the second round of plans. In fact, the firms have 
now submitted a third round of plans----
    Senator Warren. I am sorry, Chairman. I am just a little 
bit confused. JPMorgan submitted a round of plans in 2012, and 
my understanding is that neither the Fed nor the FDIC said that 
those plans were not credible. It then submitted plans in 2013, 
and neither the Fed nor the FDIC said they were not credible. 
And it has submitted plans in 2014.
    So I am not quite sure----
    Ms. Yellen. We have not even----
    Senator Warren. ----whether you are saying the plans are 
not credible and you are continuing to talk with them and 
asking them to change their plans. Is that the case?
    Ms. Yellen. We are working to give these firms feedback on 
their second round of submissions, and I think what we need to 
do is to give them a road map for where we see obstacles to 
orderly resolution under the bankruptcy Code----
    Senator Warren. Well----
    Ms. Yellen. ----and to give them an opportunity to address 
those obstacles.
    Senator Warren. I appreciate that you are doing that, but 
the statute, it seems to me, is pretty clear here, that it is 
mandatory that these plans be submitted each year and that each 
year you determine whether or not the plans are credible. And I 
guess the question I am asking is: Have they ever gotten to a 
plan that you can say with a straight face is credible?
    Ms. Yellen. I have understood this to be a process that 
these are extremely complex documents for these firms to 
produce. Our second round of submissions, we are looking at 
plans that run into tens of thousands of pages. And I think 
what was intended is that this determination you are talking 
about, about whether or not they are credible, the question is, 
Do they facilitate an orderly resolution? And I think we need 
to give these firms feedback----
    Senator Warren. So I will stop there because we are running 
out of time, but I have to say, Chair Yellen, I think the 
language in the statute is pretty clear that you are required, 
the Fed is required to call it every year on whether these 
institutions have a credible plan. And I remind you, there are 
very effective tools that you have available to you that you 
can use if those plans are not credible, including forcing 
these financial institutions to simplify their structure or 
forcing them to liquidate some of their assets--in other words, 
break them up.
    And I just want to say one more thing about this process. 
The plans are designed not just to be reviewed by the Fed and 
the FDIC, but also to bring some kind of confidence to the 
marketplace and to the American taxpayer that, in fact, there 
really is a plan for doing something if one of these banks 
starts to implode.
    You said that these plans run to the tens of thousands of 
pages. All I can say is that what has been released to the 
public is 35 pages long. That is about one page for every 100 
subsidiaries that have been to be dealt with. I think that the 
plans that have been released by these companies have not been 
something that the public can look at and say, yeah, I see that 
they have got a plan to get through this.
    So I hope you would urge greater transparency by these 
large financial institutions that are required to submit these 
plans, and I hope the Fed will be making a call on whether or 
not the Fed under its statutory responsibility sees these plans 
as credible for resolving these financial institutions if they 
hit financial trouble. Thank you.
    Thank you, Mr. Chairman.
    Chairman Johnson. Chair Yellen, I would like to thank you 
for your testimony. This hearing is adjourned.
    Ms. Yellen. Thank you, Mr. Chairman.
    [Whereupon, at 12:06 p.m., the hearing was adjourned.]
    [Prepared statements, responses to written questions, and 
additional material supplied for the record follow:]
                 PREPARED STATEMENT OF JANET L. YELLEN
        Chair, Board of Governors of the Federal Reserve System
                             July 15, 2014
    Chairman Johnson, Ranking Member Crapo, and Members of the 
Committee, I am pleased to present the Federal Reserve's semiannual 
Monetary Policy Report to the Congress. In my remarks today, I will 
discuss the current economic situation and outlook before turning to 
monetary policy. I will conclude with a few words about financial 
stability.
Current Economic Situation and Outlook
    The economy is continuing to make progress toward the Federal 
Reserve's objectives of maximum employment and price stability.
    In the labor market, gains in total nonfarm payroll employment 
averaged about 230,000 per month over the first half of this year, a 
somewhat stronger pace than in 2013 and enough to bring the total 
increase in jobs during the economic recovery thus far to more than 9 
million. The unemployment rate has fallen nearly 1\1/2\ percentage 
points over the past year and stood at 6.1 percent in June, down about 
4 percentage points from its peak. Broader measures of labor 
utilization have also registered notable improvements over the past 
year.
    Real gross domestic product (GDP) is estimated to have declined 
sharply in the first quarter. The decline appears to have resulted 
mostly from transitory factors, and a number of recent indicators of 
production and spending suggest that growth rebounded in the second 
quarter, but this bears close watching. The housing sector, however, 
has shown little recent progress. While this sector has recovered 
notably from its earlier trough, housing activity leveled off in the 
wake of last year's increase in mortgage rates, and readings this year 
have, overall, continued to be disappointing.
    Although the economy continues to improve, the recovery is not yet 
complete. Even with the recent declines, the unemployment rate remains 
above Federal Open Market Committee (FOMC) participants' estimates of 
its longer-run normal level. Labor force participation appears weaker 
than one would expect based on the aging of the population and the 
level of unemployment. These and other indications that significant 
slack remains in labor markets are corroborated by the continued slow 
pace of growth in most measures of hourly compensation.
    Inflation has moved up in recent months but remains below the 
FOMC's 2 percent objective for inflation over the longer run. The 
personal consumption expenditures (PCE) price index increased 1.8 
percent over the 12 months through May. Pressures on food and energy 
prices account for some of the increase in PCE price inflation. Core 
inflation, which excludes food and energy prices, rose 1\1/2\ percent. 
Most committee participants project that both total and core inflation 
will be between 1\1/2\ and 1\3/4\ percent for this year as a whole.
    Although the decline in GDP in the first quarter led to some 
downgrading of our growth projections for this year, I and other FOMC 
participants continue to anticipate that economic activity will expand 
at a moderate pace over the next several years, supported by 
accommodative monetary policy, a waning drag from fiscal policy, the 
lagged effects of higher home prices and equity values, and 
strengthening foreign growth. The committee sees the projected pace of 
economic growth as sufficient to support ongoing improvement in the 
labor market with further job gains, and the unemployment rate is 
anticipated to continue to decline toward its longer-run sustainable 
level. Consistent with the anticipated further recovery in the labor 
market, and given that longer-term inflation expectations appear to be 
well anchored, we expect inflation to move back toward our 2 percent 
objective over coming years.
    As always, considerable uncertainty surrounds our projections for 
economic growth, unemployment, and inflation. FOMC participants 
currently judge these risks to be nearly balanced but to warrant 
monitoring in the months ahead.
Monetary Policy
    I will now turn to monetary policy. The FOMC is committed to 
policies that promote maximum employment and price stability, 
consistent with our dual mandate from the Congress. Given the economic 
situation that I just described, we judge that a high degree of 
monetary policy accommodation remains appropriate. Consistent with that 
assessment, we have maintained the target range for the Federal funds 
rate at 0 to \1/4\ percent and have continued to rely on large-scale 
asset purchases and forward guidance about the future path of the 
Federal funds rate to provide the appropriate level of support for the 
economy.
    In light of the cumulative progress toward maximum employment that 
has occurred since the inception of the Federal Reserve's asset 
purchase program in September 2012 and the FOMC's assessment that labor 
market conditions would continue to improve, the committee has made 
measured reductions in the monthly pace of our asset purchases at each 
of our regular meetings this year. If incoming data continue to support 
our expectation of ongoing improvement in labor market conditions and 
inflation moving back toward 2 percent, the committee likely will make 
further measured reductions in the pace of asset purchases at upcoming 
meetings, with purchases concluding after the October meeting. Even 
after the committee ends these purchases, the Federal Reserve's sizable 
holdings of longer-term securities will help maintain accommodative 
financial conditions, thus supporting further progress in returning 
employment and inflation to mandate-consistent levels.
    The committee is also fostering accommodative financial conditions 
through forward guidance that provides greater clarity about our policy 
outlook and expectations for the future path of the Federal funds rate. 
Since March, our postmeeting statements have included a description of 
the framework that is guiding our monetary policy decisions. 
Specifically, our decisions are and will be based on an assessment of 
the progress--both realized and expected--toward our objectives of 
maximum employment and 2 percent inflation. Our evaluation will not 
hinge on one or two factors, but rather will take into account a wide 
range of information, including measures of labor market conditions, 
indicators of inflation and long-term inflation expectations, and 
readings on financial developments.
    Based on its assessment of these factors, in June the committee 
reiterated its expectation that the current target range for the 
Federal funds rate likely will be appropriate for a considerable period 
after the asset purchase program ends, especially if projected 
inflation continues to run below the committee's 2 percent longer-run 
goal and provided that inflation expectations remain well anchored. In 
addition, we currently anticipate that even after employment and 
inflation are near mandate-consistent levels, economic conditions may, 
for some time, warrant keeping the Federal funds rate below levels that 
the committee views as normal in the longer run.
    Of course, the outlook for the economy and financial markets is 
never certain, and now is no exception. Therefore, the committee's 
decisions about the path of the Federal funds rate remain dependent on 
our assessment of incoming information and the implications for the 
economic outlook. If the labor market continues to improve more quickly 
than anticipated by the committee, resulting in faster convergence 
toward our dual objectives, then increases in the Federal funds rate 
target likely would occur sooner and be more rapid than currently 
envisioned. Conversely, if economic performance is disappointing, then 
the future path of interest rates likely would be more accommodative 
than currently anticipated.
    The committee remains confident that it has the tools it needs to 
raise short-term interest rates when the time is right and to achieve 
the desired level of short-term interest rates thereafter, even with 
the Federal Reserve's elevated balance sheet. At our meetings this 
spring, we have been constructively working through the many issues 
associated with the eventual normalization of the stance and conduct of 
monetary policy. These ongoing discussions are a matter of prudent 
planning and do not imply any imminent change in the stance of monetary 
policy. The committee will continue its discussions in upcoming 
meetings, and we expect to provide additional information later this 
year.
Financial Stability
    The committee recognizes that low interest rates may provide 
incentives for some investors to ``reach for yield,'' and those actions 
could increase vulnerabilities in the financial system to adverse 
events. While prices of real estate, equities, and corporate bonds have 
risen appreciably and valuation metrics have increased, they remain 
generally in line with historical norms. In some sectors, such as 
lower-rated corporate debt, valuations appear stretched and issuance 
has been brisk. Accordingly, we are closely monitoring developments in 
the leveraged loan market and are working to enhance the effectiveness 
of our supervisory guidance. More broadly, the financial sector has 
continued to become more resilient, as banks have continued to boost 
their capital and liquidity positions, and growth in wholesale short-
term funding in financial markets has been modest.
Summary
    In sum, since the February Monetary Policy Report, further 
important progress has been made in restoring the economy to health and 
in strengthening the financial system. Yet too many Americans remain 
unemployed, inflation remains below our longer-run objective, and not 
all of the necessary financial reform initiatives have been completed. 
The Federal Reserve remains committed to employing all of its resources 
and tools to achieve its macroeconomic objectives and to foster a 
stronger and more resilient financial system.
    Thank you. I would be pleased to take your questions.
        RESPONSES TO WRITTEN QUESTIONS OF SENATOR CRAPO
                      FROM JANET L. YELLEN

Q.1. I referenced in my opening statement your recent speech in 
which you discussed the macroprudential tools available to the 
Fed. Given the international structure of our markets, I am 
concerned that the use of these tools may simply disadvantage 
U.S. markets. How will the Fed make sure that other 
jurisdictions follow our lead so that our financial markets 
aren't put at a competitive disadvantage when it comes to 
serving the global financial system?

A.1. Macroprudential policies are designed to promote the 
stability and resilience of the financial system in the United 
States. These features surely contribute to the attractiveness 
of U.S. financial markets to international capital. That said, 
as you note, given the highly interconnected nature of capital 
markets, coordinating actions with authorities in other 
countries is crucial. For that reason, we work closely with 
other jurisdictions in venues such as the Financial Stability 
Board (FSB) and the Basel Committee on Banking Supervision to 
craft regulations that do not disadvantage markets or 
institutions in the United States.
    For example, the Basel III capital accord contains a key 
macroprudential tool, the countercyclical capital buffer, which 
countries can put in place to provide additional loss-absorbing 
capacity to the banking system if they see building risks to 
the financial system. This tool could put U.S. banks at a 
competitive disadvantage if the United States were to implement 
the countercyclical capital buffer when other countries did 
not.
    However, the Basel III accord requires that banks' capital 
ratios be an average of the capital ratios in place across 
countries, weighted by each bank's presence in those countries. 
Thus, foreign banks operating in the United States would be 
subject to the same effective capital requirement as U.S. banks 
when making loans to households and businesses in the United 
States.
    In addition, in February 2014, the Federal Reserve approved 
a final rule that, in part, required foreign banking 
organizations with a significant U.S. presence to establish 
intermediate holding companies over their U.S. subsidiaries. 
One result of this rule is to put in place a level playing 
field among all banking organizations operating in the United 
States. In other words, they would all be subject to 
essentially the same set of micro- and macroprudential 
supervision and regulation.
    Finally, it is instructive to consider the experience of 
other developed economies with macroprudential policies. A 
variety of macroprudential policies, ranging from loan-level 
underwriting standards, such as minimum downpayments on homes, 
to policies designed to limit leverage in the whole financial 
sector, such as capital surcharges on banks, have been put in 
place by countries including Canada, Norway, and Switzerland. 
These policies have not, so far as we can observe, resulted in 
a notable decline of the attractiveness of these countries to 
global capital. Of course, these policies are still relatively 
new, and we are closely monitoring their ultimate impacts.

Q.2. The bank regulatory agencies are now seeking public 
comment on the regulations that are outdated, unnecessary, or 
unduly burdensome. I applaud your effort on this issue and 
encourage other regulators to follow the same path. It's 
important to acknowledge that these regulations don't just 
impact the banks--they affect the availability and cost of 
credit and financial services for small businesses and ordinary 
Americans. How does the Fed plan to lead this process and how 
will it achieve its goals?

A.2. The Economic Growth and Regulatory Paperwork Reduction Act 
of 1996 (EGRPRA) requires that regulations prescribed by the 
Federal banking agencies be reviewed by the agencies at least 
once every 10 years. The purpose of this review is to identify 
outdated, unnecessary, or unduly burdensome regulations and 
consider how to reduce regulatory burden on insured depository 
institutions while, at the same time, ensuring their safety and 
soundness and the safety and soundness of the financial system. 
In connection with the review, the agencies are required to 
categorize the regulations and publish requests for comment on 
how burden may be reduced. Finally, the agencies must provide a 
report to Congress summarizing significant issues, the relative 
merits of such issues, and whether the issues can be addressed 
by regulation or would require legislative action.
    The Federal Reserve, working with the Office of the 
Comptroller of the Currency (OCC), Federal Deposit Insurance 
Corporation (FDIC) and Federal Financial Institutions 
Examination Council, published the first of four anticipated 
requests for comment on agency regulations on June 4, 2014. The 
next request for comment is expected to be published before 
year end. We are especially interested to hear from community 
banks and their customers.
    In addition to the requests for public comment, we intend 
to hold several public meetings around the country in order to 
allow the industry and the public an opportunity to present 
their views on burden reduction directly to agency personnel. 
The meetings will allow bankers, consumers, representatives of 
trade or public interest groups, and bank customers to provide 
their perspectives on how regulations should be changed to 
promote efficiency and effectiveness, reduce costs and limit 
burden. Although the focus of the exercise is on regulatory 
burden reduction, all members of the public may submit comments 
on how bank regulation may affect their relationship with their 
banks and their ability to obtain credit.
    The Federal Reserve is committed to an effective review of 
its regulations to change any outdated, unnecessary, or overly 
burdensome rules. To that end, we have devoted considerable 
staff time to the process so far and will continue to do so. 
Over a dozen agency staff are currently involved in the public 
comment process and in planning the public outreach meetings 
which will be held at various Federal Reserve Banks. Each 
public meeting will be attended by a number of Federal Reserve 
staff, including senior officers from the Board and the Reserve 
Banks. As the process continues, additional staff will 
participate in reviewing the comments, assessing the burden 
associated with the targeted regulations, preparing the report 
to Congress and preparing any recommendations for changes to 
the regulations.

Q.3. Chair Yellen, 2 weeks ago you stated in a speech that 
reforms to the triparty repo market and money market mutual 
funds ``has, at times, been frustratingly slow.'' Given the 
importance of these markets and instruments, isn't the goal of 
such reforms not to get these rules done, but to get them done 
right and minimize unintended consequences? Can you please 
elaborate on your comments?

A.3. Given the centrality of both the triparty repo market and 
money market funds (MMFs) to the 2008 financial crisis, the 
pace of reforms indeed has, at times, been frustratingly slow. 
As recently as 2012, the triparty repo market continued to be 
massively dependent on discretionary intraday credit from the 
large clearing banks in the daily settlement process. And it 
was only in 2013, that the Securities and Exchange Commission 
(SEC) formally proposed rules for structural reforms aimed at 
making MMFs, and therefore the financial system, more 
resilient.
    The situation has improved markedly since 2013. Reform 
efforts in the triparty market have already begun to bear 
fruit. The share of the market financed by intraday credit has 
dropped by some 70 percentage points over the past year. By the 
end of 2014, the longstanding goal of largely eliminating such 
credit from the triparty settlement process should be reached. 
Earlier this year, the SEC finalized rules intended to address 
the structural vulnerability of MMFs. The reforms represent a 
significant step to making the MMFs more resilient. However, I 
and others have expressed concerns about some elements and 
emphasized the need to monitor the overall effects of the 
package and their implications for systemic risk going forward.
    Certainly a key explanation for the slow pace of reform in 
these critical areas is that the triparty market and MMFs both 
connect disparate parts of the financial system, including 
large financial institutions, asset management firms, and 
nonfinancial corporations. For that reason, when MMFs faced 
runs and the triparty repo market ceased to function, the 
consequences were visible throughout the financial system. The 
importance of triparty repo and MMFs also complicated 
subsequent efforts to address the vulnerabilities, as reform 
efforts must involve a wide range of stakeholders and be 
consistent with a variety of different commercial and 
regulatory requirements. We believe that a reasonable balance 
has generally been struck between the need to address very 
significant vulnerabilities and the need to proceed carefully, 
with an awareness of the broad range of possible implications 
of reforms.

Q.4. It has been reported that the FSOC is undertaking efforts 
to consider SIFI designations for asset managers. Designation 
would subject these firms to dual regulation by the Federal 
Reserve and the SEC. Are you concerned that this potential dual 
regulation of asset managers that are SIFIs by both the Fed and 
the SEC is going to lead to regulatory confusion and 
uncertainty for the markets, and how do you plan to address 
those concerns?

A.4. The Dodd-Frank Wall Street Reform and Consumer Protection 
Act (Dodd-Frank Act) established the Financial Stability 
Oversight Council (FSOC) to bring together regulators from 
across the U.S. financial system to coordinate their efforts to 
identify, monitor, and address potential threats to the 
Nation's financial stability. As part of this work, the Council 
is currently assessing potential risks arising from the asset 
management industry and its industrywide activities. That work 
is ongoing and has yet to reach any conclusions. Moreover, 
there is no sense in which its outcome is preordained in any 
way.
    It is possible that at the end of the FSOC's review it may 
decide to take no action. However, in the event that the FSOC 
were to identify specific financial stability risks from asset 
managers or their activities, it has a number of policy options 
at its disposal. These include: communicating potential threats 
to stability in its annual report to Congress; recommending 
that existing primary regulators apply heightened standards and 
safeguards; and designating individual firms as systemically 
important financial institutions, thereby subjecting them to 
supervision and regulation by the Federal Reserve. The 
appropriate response will depend upon the nature of the risks 
identified; in the event that no material risks are identified, 
the FSOC need not take action.
    The Federal Reserve routinely coordinates supervision of 
domestic bank holding companies with a number of other 
agencies, including the SEC; together, the relevant agencies 
strive to minimize any potential for mixed messages to banks or 
market participants. Regarding institutions designated by the 
FSOC, Federal Reserve said it will apply enhanced prudential 
standards to these institutions through a subsequently issued 
order or rule following an evaluation of the business model, 
capital structure, and risk profile of each designated nonbank 
financial company. This tailoring of orders and rules will 
mitigate regulatory confusion and the potential for market 
disruption.
    The Federal Reserve is committed to continuing to work in a 
coordinated manner with our fellow regulators on the FSOC to 
ensure that the organizations we supervise operate in a safe 
and sound manner and are able to provide financial 
intermediation services in a durable way to support economic 
activity in the wider economy.

Q.5. Building upon that last question, I would like to get your 
input on a recent statement by Federal Reserve Governor Tarullo 
that one way asset managers may be regulated is through Fed-
imposed margin requirements on their collateralized lending. 
This could have a major adverse effect on the availability of 
credit in the U.S. economy. As the Fed is pondering how best to 
regulate nonbank SIFIs, including asset managers, what kind of 
a cost-benefit analysis bas the Fed done to get a clear 
understanding of the effect the new regulatory framework will 
have on these entities and the economy at large?

A.5. In his recent testimony before the U.S. Senate Committee 
on Banking, Housing, and Urban Affairs, Governor Daniel K. 
Tarullo, outlined the merits of introducing a minimum 
``haircut,'' or downpayment requirement, for securities 
financing transactions (SFTs), a category of secured financing 
that is typically short-term and highly leveraged, of which 
repurchase agreements (i.e., repos) are an example. This is a 
policy recommendation being considered and developed by the 
FSB. \1\
---------------------------------------------------------------------------
     \1\ See ``Dodd-Frank Implementation'', Testimony before the 
Committee on Banking; Housing, and Urban Affairs, U.S. Senate, 
Washington, DC, September 9, 2014. Last August, the FSB issued a 
consultative document that represented an initial step toward the 
development of a framework of numerical floors, see ``Strengthening 
Oversight and Regulation of Shadow Banking: Policy Framework for 
Addressing Shadow Banking Risks in Securities Lending and Repos'', 
Financial Stability Board (2013).
---------------------------------------------------------------------------
    Minimum haircuts on SFTs would complement post-crisis 
reforms aimed at bolstering the stability of the banking 
sector, such as Basel III. A potential unintended consequence 
of those banking sector reforms is that systemically risky 
activity might be driven out of banks and into parts of the 
financial system where prudential rules do not apply or are 
less stringent.
    Like minimum margin requirements for derivatives, numerical 
floors for SFT haircuts would be intended to serve as a 
mechanism for limiting the build-up of leverage at the security 
level and could mitigate the risk of procyclical margin calls. 
\2\ Put another way, in good times, haircuts tend to fall to 
extremely low levels because market participants perceive there 
to be little risk. In the event of a sharp drop in asset 
prices, market participants suddenly raise haircuts in 
reaction. As a result, borrowers find themselves scrambling to 
finance their holdings and sometimes dump assets. The resulting 
``fire sale'' price drop harms all market participants, 
including those who operated more prudently. A minimum margin 
requirement limits the extent to which such risk can build up.
---------------------------------------------------------------------------
     \2\ See Governor Daniel K. Tarullo, Remarks at the Americans for 
Financial Reform and Economic Policy Conference, ``Shadow Banking and 
Systemic Risk Regulation'', Washington, DC, November 22, 2013.
---------------------------------------------------------------------------
    In addition, by limiting the extent to which unregulated 
entities can borrow against risky collateral, minimum haircuts 
could in principle limit the build-up of excessive leverage 
outside the banking system. Haircuts that are more stable 
through the cycle may also help to reduce other forms of 
procyclicality of the financial system such as the tendency for 
credit to be cheap and plentiful in economic expansions only to 
dry up for some borrowers in downturns. \3\
---------------------------------------------------------------------------
     \3\ For an overview of these issues, see Committee on the Global 
Financial System (2010), ``The Role of Margin Requirements and Haircuts 
in Procyclicality'', CGFS Papers No 36.
---------------------------------------------------------------------------
    The FSB minimum haircut proposals would not amount to 
regulating asset managers per se and it would leave important 
sources of financing untouched. In their current form, the 
proposals would apply only to SFTs in which entities not 
subject to capital and liquidity regulation (e.g., hedge funds) 
receive financing from entities that are subject to regulation 
(e.g., banks and broker-dealers), and only to transactions in 
which the collateral is something other than Government or 
agency securities. This could place an upper bound on the 
amount of leverage that a hedge fund could obtain from a prime 
broker if the prime broker would have been willing to accept 
haircuts below the minimum. However, other activities of asset 
managers in this market--such as money market funds' supply of 
funding to banks through the triparty repo market--would not be 
affected.
    The FSB has undertaken a quantitative impact study to 
assess the potential impact and unintended consequences 
associated with its recommendations on minimum haircuts. The 
results of this study have been used to inform the proposed 
calibration of the numerical floors at relatively low levels. 
These proposals remain under development at the FSB.

Q.6. As you know, regulators are subject to the Regulatory 
Flexibility Analysis to consider the impact of newly proposed 
rules on small entities. The agencies have determined that the 
final Volcker rule will not have a significant economic impact 
on a substantial number of small banking entities with total 
assets of $500 million of less. Yet, Dodd-Frank exempts from a 
number of its requirements entities with total consolidated 
assets of $10 billion and less. The difference between $500 
million and $10 billion is significant enough to raise 
concerns. Would your agency's Regulatory Flexibility analysis 
in the Volcker rule be any different if the $10 billion 
threshold were applied? If so, how?

A.6. Section 619 Dodd-Frank Act, which added a new section 13 
to the Bank Holding Company Act (BHC Act), generally prohibits 
any banking entity from engaging in proprietary trading, and 
from acquiring or retaining an ownership interest in, 
sponsoring, or having certain relationships with a covered 
fund, subject to certain exemptions. Under the terms of the 
statute, section 13 applies to any banking entity regardless of 
its size.
    Section 4 of the Regulatory Flexibility Act (RFA) requires 
an agency to prepare a final regulatory flexibility analysis 
for a final rule unless the agency certifies that the rule will 
not have a significant economic impact on a substantial number 
of small entities, defined as of July 22, 2013, to include 
banking entities with total assets of $500 million or less 
(small banking entities). \4\ As you know, the five agencies 
with rule-writing authority under section 13 of the BHC Act, 
including the Federal Reserve, the OCC, the FDIC, the SEC, and 
the Commodity Futures Trading Commodities (the Agencies) 
considered the potential economic impact of the final rule on 
small banking entities in accordance with the RFA, and 
determined that the final rule would not have a significant 
economic impact on a substantial number of small banking 
entities as defined by the RFA largely because banking entities 
with assets of $500 million or less generally do not engage in 
the types of activities covered by section 619 of the Dodd-
Frank Act.
---------------------------------------------------------------------------
     \4\ As of July 14, 2014, the threshold is $550 million in total 
assets or less. See 13 CFR 121.201.
---------------------------------------------------------------------------
    In drafting the implementing rules, the Agencies considered 
the effect of section 619 on banking entities that are not the 
focus of the RFA. In particular, the Agencies designed the 
implementing rules to minimize the compliance burden on banking 
entities with $10 billion or less in total assets by tiering 
the compliance program and reporting requirements based on the 
size and level of covered activity of the banking entity. For 
example, section 248.20(f)(1) of the final rule provides that a 
banking entity, regardless of size, that does not engage in 
covered trading activities (other than trading in U.S. 
Government or agency obligations, obligations of specified 
Governments sponsored enterprises, and State and municipal 
obligations) or covered fund activities and investments need 
only establish a compliance program prior to becoming engaged 
in such activities or making such investments. \5\ In addition, 
a banking entity with total consolidated assets of $10 billion 
or less that engages in covered trading activities and/or 
covered fund activities may satisfy the requirements of the 
final rule by including in its existing compliance policies and 
procedures appropriate references to the requirements of 
section 13 and the final rule and adjustments as appropriate 
given the activities, size, scope and complexity of the banking 
entity. \6\ This reduces the compliance program requirements 
for these banking entities. Only those banking entities with 
total assets of greater than $10 billion are required to adopt 
more detailed or enhanced compliance requirements under the 
final rule. \7\
---------------------------------------------------------------------------
     \5\ 12 CFR 248.20(f)(1).
     \6\ 12 CFR 248.20(f)(2).
     \7\ 12 CFR 248.20(b) and (c).
---------------------------------------------------------------------------
    Moreover, the final rule establishes a high threshold for 
metrics reporting to capture only firms that engage in 
significant trading activities. Specifically, the metrics 
reporting requirements under section 248.20 and Appendix A of 
the final rule apply only to banking entities with average 
trading assets and liabilities on a consolidated worldwide 
basis for the preceding year equal to or greater than $10 
billion. \8\ The compliance program also limits the special 
covered fund documentation requirements to banking entities 
with more than $10 billion in total consolidated assets. \9\
---------------------------------------------------------------------------
     \8\ 12 CFR 248.20(d).
     \9\ 12 CFR 248.20(e).
---------------------------------------------------------------------------
    To help community banks understand the requirements of 
section 619 and the implementing rules, the Agencies also 
released a fact sheet regarding the application of section 13 
of the final rule to community banks (i.e., those with less 
than $10 billion in total consolidated assets). \10\ The fact 
sheet provides useful information about provisions of the final 
rules designed to reduce burden on community banks.
---------------------------------------------------------------------------
     \10\ See ``The Volcker Rule: Community Bank Applicability'', (Dec. 
10, 2013), available at http://www.federalreserve.gov/newsevents/press/
bcreg/bcreg20131210a4.pdf.
---------------------------------------------------------------------------
    Thus, while the RFA focuses on banking entities with assets 
of $500 million or less, in developing the final rule, the 
Agencies tried to minimize the impact of the final rule on 
banking entities with total assets of $10 billion or less.

Q.7. I have heard concerns from banks that are subject to the 
Fed's annual stress tests that the ever-changing criteria for 
these tests creates uncertainty and lack of transparency. One 
of the main complaints from banks is that they do not fully 
understand why the Federal Reserve's calculations differ from 
their internal calculations. Last week, the House Financial 
Services Committee held a hearing on a bill that requires the 
Federal Reserve to disclose more details about the annual 
stress test process including formal rules for stress testing, 
which the Comptroller General and the Congressional Budget 
Office would review. Do you agree that the Fed should publish 
such formal rules to give more clarity to public and Congress 
on these stress tests?

A.7. The Federal Reserve believes that transparency in its 
stress testing is extremely important and has taken several 
steps to enhance the transparency of the stress tests and 
comprehensive capital analysis and review. For example, last 
November, in order to allow the public to better understand the 
Federal Reserve's process for designing scenarios, the Federal 
Reserve issued a Policy Statement on the Scenario Design 
Framework for Stress Testing. \11\ Each year, the Federal 
Reserve publishes a detailed overview of its stress testing 
methodologies, including a description of the types of models 
employed in the supervisory stress test. \12\ In addition, the 
Federal Reserve hosts an annual stress test modeling symposium, 
which brings together experts from the regulatory community and 
the banking industry to share diverse views and experiences in 
stress test modeling and to help improve the general 
understanding of stress test modeling practices and 
applications. \13\ Thus, the Federal Reserve is already 
providing a substantial amount of the information about the 
annual stress tests.
---------------------------------------------------------------------------
     \11\ See p. 71443 of Board of Governors of the Federal Reserve 
System, ``Policy Statement on the Scenario Design Framework for Stress 
Testing'', November 2013, available online at: www.federalreserve.gov/
newsevents/press/bcreg/20131107a.htm.
     \12\ See Board of Governors of the Federal Reserve System, ``Dodd-
Frank Act Stress Test 2014: Supervisory Stress Test Methodology and 
Results'', March 2014, available online at: www.federalreserve.gov/
newsevents/press/bcreg/bcreg20140320a1.pdf.
     \13\ http://www.bostonfed.org/2014STM/index.htm
---------------------------------------------------------------------------
    In evaluating the optimal level of model and scenario 
disclosure, supervisors must balance the desire for 
transparency against the benefits of model diversity and 
potential for negative consequences, such as model convergence 
or a shift in business activity to areas where risks may not be 
well captured by the stress testing models. Formal rules for 
stress testing that include providing companies with the 
scenarios, methodologies, and loss models in advance of the 
supervisory stress test would undermine the credibility and 
effectiveness of the stress tests.
    By releasing the Federal Reserve's process for designing 
the scenarios and conducting the supervisory stress test, we 
are able to make the process more transparent and predictable, 
without eliminating the flexibility to make improvements and 
incorporate new risks that may develop over time. If the 
Federal Reserve was required to specify a static set of 
scenarios and the specific models employed in the stress test 
through notice and comment rulemaking, then covered companies 
would be able to adjust their business models to focus on 
activities that are not captured in the particular supervisory 
stress test. Each year, the Federal Reserve has refined 
elements of both the substance and process of the annual stress 
tests. These changes have been informed not only by our own 
experience, but also by critiques and suggestions offered by 
others. The Federal Reserve will continue to consider 
appropriate enhancements to the stress test. In order to give 
regulators, banks, and the public a dynamic view of the capital 
positions of large financial firms, supervisory stress testing 
must itself respond to changes in the economy, the financial 
system, and risk-management capabilities. Preliminary research 
by Federal Reserve System economists found that not updating 
supervisory stress scenarios and models was a key factor in the 
failure of the supervisory stress tests conducted on Fannie Mae 
and Freddie Mac before the financial crisis. \14\
---------------------------------------------------------------------------
     \14\ See Scott Frame, Kristopher Gerardi, and Paul Willen, 
``Supervisory Stress Tests, Model Risk, and Model Disclosure: Lessons 
From OFHEO'', April 2013. Available online at: www.frbatlanta.org/ 
documents/news/conferences/13fmc_gerardi.pdf.
---------------------------------------------------------------------------
    Finally, if the Federal Reserve released the models it uses 
in its stress test, that would eliminate incentives for 
companies to develop their own models to assess how their 
businesses and exposures could be affected by stress. There is 
no single model that can capture every risk to financial 
companies, and overreliance on a single approach that is 
tailored to assess the industry as a whole would make it far 
more likely that new risks that develop would be missed, 
potentially undermining financial stability. Reliance on a 
single model also allows for a larger probability of a single 
common failure of that model, potentially underestimating the 
risk of losses.
                                ------                                


               RESPONSES TO WRITTEN QUESTIONS OF
             SENATOR MENENDEZ FROM JANET L. YELLEN

Q.1. As the Fed has engaged in measures to strengthen our 
economy since the financial crisis, some critics have argued 
that any growth that results might somehow be ``artificial,'' 
or that the economy is on some kind of unsustainable ``sugar 
high'' due to supposedly ``unnaturally low'' interest rates.
    If you look at the underlying economic conditions, though, 
inflation has been consistently below the Fed's target. Our 
economy has been creating jobs--the private sector has now 
created jobs for 52 straight months, the longest streak on 
record--but we still have work to do to return our labor 
markets to full strength after the damage done by the financial 
crisis and Great Recession.
    If anything, the data say we should have had even more 
stimulus in response to the recession, and that pulling back 
too soon now risks undoing the progress we've made so far.
    Aren't low interest rates appropriately reflective of 
economic conditions? If the biggest challenge facing our 
economy is the need for demand to keep getting stronger, and 
investors seem to be requiring low returns because of a 
perceived lack of investment opportunities, wouldn't it be more 
``artificial'' for the Fed to impose higher interest rates than 
what market conditions dictate, and risk choking off growth or 
creating deflation?

A.1. The Federal Open Market Committee (committee) designs its 
policy in light of the dual mandate that the Congress has set 
for the Federal Reserve--namely, to promote price stability and 
maximum sustainable employment. Necessarily, the policy 
judgments that the committee makes are conditioned on the 
current state of the economy and the prospects for the future 
evolution of the economy, as best as the committee can discern 
them. As the committee noted in its most recent post-meeting 
statement, released July 30, 2014, ``The Committee expects 
that, with appropriate policy accommodation, economic activity 
will expand at a moderate pace, with labor market indicators 
and inflation moving toward levels the Committee judges 
consistent with its dual mandate.'' If the committee were to 
maintain too restrictive a policy, it would risk failing to 
best promote the two legs of the dual mandate, resulting in 
employment below its maximum sustainable level, and inflation 
running persistently below the 2 percent objective identified 
by the committee as most consistent with its dual mandate.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR VITTER
                      FROM JANET L. YELLEN

Q.1. As you know Section 113 of the Dodd-Frank Act authorizes 
FSOC to designate nonbank financial companies as SIFI 
(systemically important financial institutions) for enhanced 
oversight and regulation by the Federal Reserve. Historically, 
the Fed has focused exclusively on banking regulation and 
monetary policy. So, Dodd-Frank has made a pretty monumental 
shift in your focus.
    So far, FSOC has designated two insurance companies for 
regulation by the Federal Reserve--American International Group 
and Prudential Financial, Inc. This is an enormous concern, as 
you are getting more and more involved yet seem wholly ill-
prepared to take on this type of supervision, both with the 
FSOC and the IAIA.
    How is the Fed preparing to regulate these companies? Has 
there been any effort to hire more employees with actual 
insurance knowledge? If you have hired any employees with 
background in insurance regulation, is this number sufficient?

A.1. The Federal Reserve has hired staff with expertise in 
insurance to supervise the savings and loan holding companies 
and designated companies for which the Federal Reserve has 
responsibility and to assist in training other Federal Reserve 
examiners and staff on insurance issues. We currently employ 
approximately 70 full-time employees for the supervision of 
insurance firms. Nearly half of these staff members having over 
10 years of supervisory experience. Our staff is comprised of 
individuals with substantial prior experience in both State 
insurance departments and industry. We plan to continue to add 
staff, as appropriate, at both the Board and the Reserve Banks. 
Board staff consult with the Federal Insurance Office on issues 
related to our supervisory framework, including insurance 
capital requirements and stress testing. Board staff also meet 
regularly with industry representatives and with the National 
Association of lnsurance Commissioners and State insurance 
regulators to discuss insurance-related issues. The Federal 
Reserve expects to continue consultations with other regulators 
and standard-setters, the Financial Stability Oversight 
Council, the industry and the public, to further the Federal 
Reserve's expertise and to gain additional perspectives on the 
regulation and supervision of insurance companies.
                                ------                                


       RESPONSES TO WRITTEN QUESTIONS OF SENATOR JOHANNS
                      FROM JANET L. YELLEN

Q.1. Chair Yellen, as you know, in Dodd-Frank, Congress never 
intended for nonfinancial end users to be subject to costly 
margin requirements when trading derivatives. Manufacturers, 
farmers, small businesses use derivatives to manage risk, not 
create it.
    We certainly do not want to see billions of dollars sucked 
out of the economy to post unnecessary margin. Not only would 
this increase the costs of hedging, which means higher prices 
for consumers, but it also restricts capital that would 
otherwise be used for job creation or reinvestment. 
Furthermore, the high costs of hedging could drive business 
overseas to foreign derivatives markets.
    There is currently a bipartisan bill in the Senate that 
exempts nonfinancial end users from posting margin (S. 888). A 
companion bill passed out of the House last year by a vote of 
411-12. Chairman Bernanke said in 2011 that he was comfortable 
with this proposal. Governor Tarullo has also indicated a 
comfort level with this approach. And the other regulators, 
CFTC and SEC, seem to agree that nonfinancial end users need to 
hedge risk and clearly do not pose a threat to the economy.
    Also, recently an international working group arranged by 
the G20 has come out in agreement and said that nonfinancial 
end users should not be subject to margin requirements. 
Chairman Bernanke, the CFTC, the SEC, the G20 officials, and 
411 House members all agree that it's ill-advised to have 
nonfinancial end users subject to costly margin requirements, 
but the Fed has yet to make this exemption clear.
    Do you support the policy goal, and the original intent of 
Congress, to exempt end users from margin requirements? In your 
hearing last week, you mentioned that the Fed was on track to 
finalize an end-user exemption rule by the end of the year. Can 
you be a little more specific on timing?
    How does the Fed intend to harmonize its rule with the 
internationally proposed standard that does not subject 
nonfinancial entities to initial margin requirements?

A.1. Although section 723 of the Dodd-Frank Wall Street Reform 
and Consumer Protection Act (Dodd-Frank Act) provides an 
explicit exemption for certain end users from the swap clearing 
requirement, there is no exemption from the margin requirement 
in section 731 or section 764 of the Dodd-Frank Act for a swap 
dealer's or major swap participant's (MSP's) swaps with end 
users. Sections 731 and 764 of the Dodd-Frank Act require the 
Commodity Futures Trading Commission, Securities and Exchange 
Commission, Federal Reserve Board (Board), and other prudential 
regulators to adopt rules for swap dealers and MSPs imposing 
initial and variation margin requirements on all noncleared 
swaps. The statute directs that these margin requirements be 
risk-based.
    Nonfinancial end users appear to pose minimal risks to the 
safety and soundness of swap dealers and to U.S. financial 
stability when they hedge commercial risks with derivatives and 
the related unsecured exposure is appropriately managed within 
a prudent and well-controlled risk management framework.
    In September 2014, the Federal Reserve and other prudential 
regulators issued a new proposal to implement Section 731 and 
764 of the Dodd-Frank Act. The new proposal builds on the 
proposal originally released by the agencies in April 2011, and 
the Basel Committee on Banking Supervision--International 
Organization of Securities Commissions framework. The new 
proposal does not require a covered swap entity to collect 
specific or minimum amounts of initial margin or variation 
margin from nonfinancial end users, but rather leaves that 
decision to the covered swap entity, consistent with its 
overall credit risk management. The agencies believe this rule 
maintains the status quo for nonfinancial end users and is 
consistent with the requirements of the Dodd-Frank Act.

Q.2. Chair Yellen, as you are aware, the Senate recently 
unanimously passed S. 2270, the Insurance Capital Standards 
Clarification Act.
    Considering this recent Congressional action, and the 
widespread agreement that any capital standards for insurers 
should be appropriately tailored, how is the Fed planning to 
design its overall supervisory regime for the insurers it 
supervises?
    How much will you rely on the standards in place at the 
State level to protect policyholders?
    Also, other than the hiring of Thomas Sullivan as a senior 
advisor, what steps have you taken to ensure that the Fed has 
the requisite expertise to regulate insurance companies?

A.2. The supervisory programs for insurance savings and loan 
holding companies and nonbank financial firms designated by the 
Financial Stability Oversight Committee (FSOC) that engage in 
insurance activities continues to be tailored to consider the 
unique characteristics of insurance operations and to rely on 
the work of the primary functional regulator(s) to the greatest 
extent possible.
    The Federal Reserve has hired staff with expertise in 
insurance to supervise the savings and loan holding companies 
and designated companies for which the Federal Reserve has 
responsibility and to assist in training other Federal Reserve 
examiners and staff on insurance issues. We currently employ 
approximately 70 full-time employees for the supervision of 
insurance firms. Nearly half of these staff members having over 
10 years of supervisory experience. Our staff is comprised of 
individuals with substantial prior experience in both State 
insurance departments and industry. We plan to continue to add 
staff, as appropriate, at both the Board and the Reserve Banks. 
Board staff consult with the Federal Insurance Office on issues 
related to our supervisory framework, including insurance 
capital requirements and stress testing. Board staff also meet 
regularly with industry representatives and with the National 
Association of insurance Commissioners and State insurance 
regulators to discuss insurance-related issues. The Board 
expects to continue consultations with other regulators and 
standard-setters, the FSOC, the industry and the public, to 
further the Board's expertise and to gain additional 
perspectives on the regulation and supervision of insurance 
companies.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR TOOMEY
                      FROM JANET L. YELLEN

Q.1. Regulators have been cracking down on activity in the 
leveraged loan market, in some cases setting effective caps on 
how much banks can lend as a multiple of EBITDA.
    Isn't the concern about leveraged lending indicative of a 
broader problem of too much liquidity reaching for yield?

A.1. The Federal Open Market Committee (committee) is committed 
to policies that promote maximum employment and price 
stability, consistent with our dual mandate from the Congress. 
Low interest rates have been and continue to be an important 
tool to promote a strong economy. As I stated in my testimony, 
however, ``the Committee recognizes that low interest rates may 
provide incentives for some investors to `reach for yield,' and 
those actions could increase vulnerabilities in the financial 
system to adverse events. While prices of real estate, 
equities, and corporate bonds have risen appreciably and 
valuation metrics have increased, they remain generally in line 
with historical norms. In some sectors, such as lower-rated 
corporate debt, valuations appear stretched and issuance has 
been brisk. Accordingly, we are closely monitoring developments 
in the leveraged loan market and are working to enhance the 
effectiveness of our supervisory guidance.''
    Specifically, in March of 2013, we issued interagency 
guidance on leverage lending along with the Federal Deposit 
Insurance Corporation (FDIC) and the Office of the Comptroller 
of the Currency (OCC), which promotes underwriting practices 
that should be employed regardless of the interest rate 
environment. This guidance includes general policy and risk 
management expectations but does not set caps on how much banks 
can lend as a multiple of earnings before interest, taxes, 
depreciation, and amortization. Regulators continue to 
highlight the importance of adhering to the leverage lending 
guidance with the institutions we supervise to help ensure 
their lending practices are safe and sound.

Q.2. If policy were to normalize, wouldn't that effectively 
reign in the amount of leveraged lending that is taking place?

A.2. In a higher rate environment, it is possible that there 
would be a shift of investor demand away from leveraged lending 
to other asset classes; however, leveraged loans have 
experienced rapid expansion in more normal interest rate 
environments as well, such as the period prior to the 2008 
financial crisis. Moreover, monetary policy faces significant 
limitations as a tool to promote financial stability, and the 
effects of monetary policy on financial vulnerabilities (such 
as excessive leverage) are not as well understood or direct as 
a regulatory or supervisory approach. And while a review of the 
empirical evidence from recent years suggests that the level of 
interest rates does influence house prices, leverage, and 
maturity transformation, it is also clear that tighter monetary 
policy is a very blunt tool, which could have sizable adverse 
effects in terms of the Federal Reserve's mandated goals of 
maximum employment and price stability. Indeed, in current 
circumstances, tighter monetary policy could, by undermining 
the economic recovery, lead to slackening loan demand and 
higher loan losses, thereby weakening U.S. financial 
institutions.
    To promote financial stability and address risk, the 
Federal Reserve has focused on its tools related to supervision 
and regulation, taking a range of steps, including 
strengthening capital and liquidity regulation of the largest 
banks and conducting annual stress tests, to strengthen the 
resiliency of the financial sector. And specifically with 
respect to leveraged lending, we have issued interagency 
guidance with the FDIC and the OCC, which promotes underwriting 
practices that should be employed regardless of the interest 
rate environment. Regulators have highlighted the importance of 
adhering to the leverage lending guidance with the institutions 
we supervise to help ensure their lending practices are safe 
and sound.

Q.3. Is it really desirable to employ more cumbersome and 
costly regulations to shield us against the negative effects of 
loose monetary policy?

A.3. As mentioned earlier, our review of the evidence from 
recent years suggests that monetary policy is a very blunt tool 
with which to address a build-up in risk-taking. In addition, 
importantly, good risk-management practices, especially in 
rapidly growing areas like leveraged lending, make sense no 
matter what the level of interest rates.
    The guidance outlines sound practices for leveraged lending 
activities that are applicable in all rate environments. The 
guidance is designed to assist financial institutions in 
providing leveraged lending to creditworthy borrowers in a 
safe-and-sound manner, while avoiding heightening risks to the 
financial system by originating poorly underwritten loans. 
Furthermore, implementation of the guidance should be 
consistent with the size and risk profile of a financial 
institution's leveraged activities relative to its assets, 
earnings, liquidity, and capital. As such, the vast majority of 
community banks should not be affected by the guidance as they 
have limited involvement in leveraged lending. The guidance 
also encourages community and smaller institutions that are 
involved in leveraged lending to discuss with their primary 
regulator the implementation of cost-effective controls 
appropriate for the complexity of their exposures and 
activities.

Q.4. In your recent appearance before the Senate Banking 
Committee, Senator Crapo asked you if reverse repurchases may 
deprive businesses of credit and you responded by saying 
initial tests have indicated that it's an effective tool and 
that by maintaining a large spread between overnight reverse 
RRPs and the interest on excess reserves, this problem could be 
mitigated. I wanted to follow up with a few questions of my 
own:
    What is the consequence of an interbank lending market 
essentially crowded out by zero interest rates?
    What is the Federal Reserve's strategy for returning to a 
robust and deep interbank lending market rather than relying on 
the Federal Reserve as the primary counterparty in short-term 
funding?

A.4. Over recent years, the committee has judged that a highly 
accommodative stance of monetary policy has been necessary to 
foster progress toward its statutory objectives of maximum 
employment and stable prices. In providing policy 
accommodation, the committee cut its target Federal funds rate 
effectively to zero by the end of 2008 and has also purchased 
large volumes of long-term Treasury and agency securities over 
recent years to put additional pressure on long-term rates. 
These actions have helped to encourage economic recovery, to 
improve conditions in labor markets, and to guard against 
disinflationary pressures. The level of reserve balances in the 
banking system has increased very substantially over recent 
years in connection with the committee's purchases of long-term 
securities. With an elevated level of reserve balances in the 
banking system, the need for banks to borrow and lend actively 
in interbank markets has dropped substantially relative to the 
levels of activity in these markets prior to the crisis. That 
said, there is still a significant volume of transactions in 
the Federal funds and other short-term bank funding markets, 
and the interest rates observed in those markets remain tightly 
linked with other short-term interest rates.
    The committee adjusts the stance of monetary policy over 
time as appropriate to foster progress toward its long-term 
objectives of maximum employment and stable prices. As the 
economy continues to recover and inflation returns toward the 
committee's 2 percent objective, the committee will adjust the 
stance of monetary policy. Part of the process will involve 
raising the level of short-term interest rates to more normal 
levels. In addition, the size and composition of the Federal 
Reserve's balance sheet will also be normalized. The level of 
reserve balances in the banking system will fall as the size of 
the Federal Reserve's balance sheet is reduced, and activity in 
the Federal funds market and other short-term bank funding 
markets likely will increase significantly as the level of 
reserve balances declines.
    The committee's statement on ``Policy Normalization 
Principles and Plans'' provides additional information 
regarding the approach the committee intends to implement when 
it becomes appropriate to begin normalizing the stance of 
monetary policy including the size and composition of the 
Federal Reserve's balance sheet.

Q.5. The Federal Reserve announced on June 4, 2014, that it, 
along with the FFIEC, the OCC, and the FDIC, are undertaking a 
review of regulations to identify those that are ``outdated, 
unnecessary, or unduly burdensome imposed on insured depository 
institutions.'' Regulatory burdens are not just borne by banks, 
but by bank customers, including the consumers and businesses 
that borrow from these institutions.
    To what extent is the Federal Reserve including access and 
cost of credit in its analysis?
    How does the Federal Reserve define ``unduly burdensome?''
    What resources has the Federal Reserve dedicated to 
conducting this review?

A.5. The Economic Growth and Regulatory Paperwork Reduction Act 
of 1996 (EGRPRA) requires that regulations prescribed by the 
Federal banking agencies be reviewed by the agencies at least 
once every 10 years. The purpose of this review is to identify 
outdated, unnecessary, or unduly burdensome regulations and 
consider how to reduce regulatory burden on insured depository 
institutions while, at the same time, ensuring their safety and 
soundness and the safety and soundness of the financial system. 
In connection with the review, the agencies are required to 
categorize the regulations and publish requests for comment on 
how burden may be reduced. Finally, the agencies must provide a 
report to Congress summarizing significant issues, the relative 
merits of such issues, and whether the issues can be addressed 
by regulation or would require legislative action.
    The Federal Reserve, working with the OCC, FDIC, and 
Federal Financial Institutions Examination Council, published 
the first of four anticipated requests for comment on agency 
regulations on June 4, 2014. The next request for comment is 
expected to be published before year end. We are especially 
interested to hear from community banks and their customers.
    In addition to the requests for public comment, we intend 
to hold several public meetings around the country in order to 
allow the industry and the public an opportunity to present 
their views on burden reduction directly to agency personnel. 
The meetings will allow bankers, consumers, representatives of 
trade or public interest groups, and bank customers to provide 
their perspectives on how regulations should be changed to 
promote efficiency and effectiveness, reduce costs, and limit 
burden. Although the focus of the exercise is on regulatory 
burden reduction, all members of the public may submit comments 
on how bank regulation may affect their relationship with their 
banks and their ability to obtain credit.
    Whether a regulation may be considered ``unduly 
burdensome'' would depend on the purpose of the particular 
regulation and the role that regulation plays in protecting the 
safety and soundness of the bank, in assuring the stability of 
the economy, and in protecting the interests of consumers of 
banking services. In addition, EGRPRA recognizes that some 
regulatory burden reductions may require legislative changes.
    The Federal Reserve is committed to an effective review of 
its regulations to change any outdated, unnecessary, or overly 
burdensome rules. To that end, we have devoted considerable 
staff time to the process so far and will continue to do so. 
Over a dozen agency staff are currently involved in the public 
comment process and in planning the public outreach meetings 
which will be held at various Reserve Banks. Each public 
meeting will be attended by a number of Federal Reserve staff, 
including senior officers from the Board and the Reserve Banks. 
As the process continues, additional staff will participate in 
reviewing the comments, assessing the burden associated with 
the targeted regulations, preparing the report to Congress and 
preparing any recommendations for changes to the regulations.

Q.6. In a hearing on March 11, I raised an issue at a hearing 
on insurance capital standards expressing concern with the 
Financial Stability Board's plans to apply a European capital 
standard to American insurance companies. I remain concerned 
that what may be appropriate for European insurers, may not be 
appropriate for their American counterparts.
    What expertise has the Federal Reserve brought in to 
regulate insurance companies?
    How is that expertise being used when the Federal Reserve 
attends FSB meetings where international insurance capital 
standards are being discussed?
    To what extent are you concerned that the FSB may force an 
unworkable insurance standard on American insurers?

A.6. The Federal Reserve has hired staff with expertise in 
insurance to supervise the savings and loan holding companies 
and designated companies for which the Federal Reserve has 
responsibility and to assist in training other Federal Reserve 
examiners and staff on insurance issues. We currently employ 
approximately 70 full-time employees for the supervision of 
insurance firms. Nearly half of these staff members have over 
10 years of supervisory experience. Our staff include 
individuals with substantial prior experience in both State 
insurance departments and the insurance industry. We plan to 
continue to add staff, as appropriate, at both the Board and 
the Reserve Banks.
    Staff with insurance expertise fully brief the Federal 
Reserve's representative to the Financial Stability Board (FSB) 
in advance of FSB meetings at which insurance-related issues 
are addressed. In addition, Federal Reserve staff participate 
actively in selected International Association of Insurance 
Supervisors (IAIS) work groups and committees that are 
developing international insurance capital standard. That 
participation is undertaken in close cooperation and 
coordination with U.S. colleagues from the National Association 
of Insurance Commissioners, the State insurance departments, 
and the Federal Insurance Office.
    The capital standard under development by the IAIS are not 
bank-centric. Moreover, they are not contemplated to replace 
existing insurance risk-based capital standards at U.S. 
domiciled insurance legal entities within the broader firm. A 
goal of the international capital standards being developed by 
the IAIS is to achieve greater comparability of the capital 
requirements of internationally active insurance groups across 
jurisdictions at the groupwide level. This should promote 
financial stability, provide a more level playing field for 
firms and enhance supervisory cooperation and coordination by 
increasing the understanding among groupwide and host 
supervisors. It should also lead to greater confidence being 
placed on the groupwide supervisors analysis by host 
supervisors.
    Any IAIS capital standard would supplement existing legal 
entity risk-based capital requirements by evaluating the 
financial activities of the firm overall rather than by 
individual legal entity. Once developed by the IAIS, each 
national supervisor would determine the extent and manner in 
which any capital standards developed by the IAIS would be 
applied to Global Systematically Important Insurers (GSIIs) 
regulated by that national supervisor. The Federal Reserve is 
fully committed to transparency and due process in the 
development and promulgation of regulatory standards. We 
support the practice of the IAIS to release for public comment 
its proposals for the basic capital requirements for GSIIs and 
expect that the IAIS will follow a similar process in the 
development of the insurance capital standards. It is important 
to note that neither the FSB nor the IAIS has the ability to 
implement requirements in any jurisdiction. Implementation in 
the United States would have to be consistent with U.S. law and 
comply with the administrative rulemaking process, including an 
opportunity for public comment.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR MORAN
                      FROM JANET L. YELLEN

Q.1. The role of Vice-Chair for Supervision was created in 
Section 1108 of Dodd-Frank. To this day, the Administration has 
not nominated anyone to fill this role. I sent a letter along 
with Sen. Johanns in July of 2012 to President Obama calling 
attention to this statutory requirement. With several hundred 
community banks under the direct supervision of the Federal 
Reserve, I would contend that this position is critically 
important to coordinate the efforts in D.C. and the regional 
Federal Reserve banks.
    I appreciate Governor Tarullo's appearances before 
Congress, however, I feel that a fundamental responsibility of 
the United States Senate is to analyze and approve of a person 
to fill a position that was created with the requirement of a 
Senate confirmation. Since the White House has not nominated 
anyone to fill this position in the 4 years since the passage 
of Dodd-Frank, it would certainly appear that the Senate's 
ability to oversee the business of the Federal Reserve is 
diminished when such a high ranking position is filled by a 
person who was not confirmed for that role.
    What efforts are currently underway by yourself and the 
Federal Reserve to convince President Obama to send a 
nomination to the Senate? If no requests from the Federal 
Reserve have been made, could you explain why this has not 
occurred?
A.1. The Dodd-Frank Wall Street Reform and Consumer Protection 
Act of 2010 (Dodd-Frank Act) designated a new position, Vice 
Chairman for Supervision, charged with developing policy 
recommendations regarding the supervision and regulation of 
firms supervised by the Federal Reserve Board (Board) and 
overseeing the supervision and regulation of such firms. In 
accordance with 12 U.S.C. 242, members of the Board, including 
the Vice Chairman for Supervision, are appointed by the 
President, by and with the advice and consent of the U.S. 
Senate. The Board currently has five members and welcomes the 
nominations of individuals to fill the remaining vacancies.
    In the absence of a Vice Chairman for Supervision, the 
Board and its members, in particular Governor Tarullo, have 
acted to fulfill the supervisory and regulatory 
responsibilities conferred on the Board by Congress and to 
provide testimony to Congress regarding these efforts. With 
respect to its supervisory and regulatory authorities, the 
Board oversees a variety of financial institutions and 
activities with the goal of promoting a safe, sound, and stable 
financial system that supports the growth and stability of the 
U.S. economy. The Board takes seriously these responsibilities. 
Following the crisis, the Board has focused on strengthening 
regulation and overhauling our supervisory framework to improve 
consolidated supervision as well as our ability to identify 
potential threats to the stability of the financial system. We 
have also worked to implement the reforms contained in the 
Dodd-Frank Act.

Q.2. With respect to the Federal Reserve's supervisory 
authority of community banks, consolidations, mergers, and 
simple bank failures are certainly some reasons for the decline 
in the number of these institutions. But the regulatory 
requirements stemming from Dodd-Frank have played a big part in 
this decline as well. I have no doubts that compliance with 
these new regulations simply became too much to bear for many 
small banks. One consequence of this decline is that the bank 
holding companies absorbing these smaller institutions fall 
under greater regulatory thresholds due to their increasing 
asset size. These small bank holding companies are increasingly 
exposed to the current $500 million threshold under the Federal 
Reserve's Small Bank Holding Company Policy Statement.
    For example, a small bank holding company located in Kansas 
has seven branches. These branches are located in rural 
communities where they are, in some instances, one of the only 
remaining businesses located on Main Street. But since a small 
bank holding company brought those small banks under its 
purview and kept a branch open for these small communities, 
that same holding company is now in excess of that $500 million 
threshold. As I understand it, the Federal Reserve has the 
discretion to alter the Small Bank Holding Company Policy 
Statement and has exercised that discretion in raising the 
threshold in the past. I have introduced legislation along with 
Sen. Tester and Sen. Kirk along with an additional 34 of our 
Senate colleagues as cosponsors. Section 3 of the CLEAR Relief 
Act, S.1349, would require the Federal Reserve to raise that 
threshold. This seems to me a commonsense reform we could make 
that would ensure that small communities across the country 
will maintain access to hometown banking services. This is only 
one example of a regulatory burden the Federal Reserve could 
lift for the betterment of community banking and it is 
consistent with some of your public comments since you became 
Chair of the Federal Reserve. Would you please outline your 
specific plan as to how you will go about reducing the 
regulatory burden on small banks, utilizing the Federal 
Reserve's discretionary regulatory framework, so that 
communities in Kansas will still have access to a hometown 
bank? If you are unable or unwilling to commit to altering the 
Small Bank Holding Company Policy Act, would you please outline 
the specific regulatory relief measures you would advocate for 
consistent with your past recognition of the unique qualities 
of community banks?

A.2. Community banking institutions play a critical role in the 
economy, and the Board is committed to putting in place 
regulatory capital rules that strike the right balance between 
achieving our safety and soundness goals and minimizing 
regulatory burden for smaller banking organizations. As you 
know, in December 2014, Congress enacted Public Law 113-250 
which directed the Board to make certain changes related to its 
Small Bank Holding Company Policy Statement (policy statement). 
Consistent with the statute, in January 2015, the Board issued 
a rulemaking that immediately excludes noncomplex savings and 
loan holding companies (SLHCs) under $500 million from the 
Board's regulatory capital rules, effectively placing them on 
equal footing with similar-sized bank holding companies. The 
Board also issued a notice of proposed rulemaking that would 
increase the policy statement's threshold level from $500 
million to $1 billion in total consolidated assets, and expand 
its scope to also include SLHCs. The comment period on the 
proposal ends on March 4th, and the Board will work to finalize 
it as quickly as possible.
    The Board also took related action to reduce the regulatory 
reporting burden for holding companies that have less than $1 
billion in total consolidated assets that meet the qualitative 
requirements of the policy statement, permitting them to reduce 
the amount and frequency of their regulatory reporting. The 
Board has filed a request with the Office of Management and 
Budget to make these changes effective beginning with reports 
filed for the period ending March 31, 2015, while it completes 
the notice and comment process.
    We are committed to promoting a stable financial system in 
a manner that does not impose a disproportionate burden on 
community banking institutions. To help us achieve these goals, 
we will continue to seek the views of the institutions we 
supervise and the public as we further develop regulatory and 
supervisory programs to preserve financial stability at the 
least cost to credit availability and economic growth.

Q.3. A growing concern that many of my colleagues and I are 
following involves the Financial Stability Board's (FSB's) 
possible effort to impose European-style insurance capital 
standards on U.S. property/casualty insurers that have not been 
designated as systemically important, but rather are just 
``internationally active.'' It is my understanding that if an 
insurer is not a SIFI or a savings and loan holding company, 
then the insurer would remain subject to the risk-based capital 
standards of the States. I have received responses from recent 
Fed nominees that mainly state that these Basel-generated rules 
would not have any legal effect in the U.S. Those responses 
seem to ignore the reality that European regulators are 
pressing for these standards to apply to non-SIFI U.S. 
insurers, and that those same regulators have any number of 
ways to force our insurers that do business in Europe to comply 
with new standards. We need to revisit this specific issue. Do 
you have any thoughts on how international capital standards 
for property casualty insurers will be received in the 
marketplace?

A.3. A goal of the international capital standard (ICS) being 
developed by the IAIS is to achieve greater comparability of 
the capital requirements of internationally active insurance 
groups (IAIGs) across jurisdictions at the groupwide level. 
This should promote financial stability, provide a more level 
playing field for firms and enhance supervisory cooperation and 
coordination by increasing the understanding among groupwide 
and host supervisors. It should also lead to greater confidence 
being placed on the groupwide supervisory analysis. The 
standards under development by the IAIS are not contemplated to 
replace existing insurance risk-based capital standards at U.S. 
domiciled insurance legal entities. Any IAIS capital standard 
would supplement existing legal entity risk-based capital 
requirements by evaluating the financial activities of the firm 
overall rather than by evaluation of individual legal entities. 
It is important to note that neither the Financial Stability 
Board, nor the IAIS, has the ability to implement requirements 
in any jurisdiction. Implementation in the United States would 
have to be consistent with U.S. law and comply with the 
administrative rulemaking process.
                                ------                                


        RESPONSES TO WRITTEN QUESTIONS OF SENATOR COBURN
                      FROM JANET L. YELLEN

Q.1. In a response to a question for the record following your 
February testimony regarding the Fed's use of forward guidance, 
you stated that ``the Committee's forward guidance is intended 
to provide the public with a better understanding of how it 
will conduct monetary policy in the future, but the guidance 
has consistently been expressed in terms of what policy would 
be appropriate in the future given the committee's current 
outlook for future economic conditions.'' Of course, there will 
always be an inherent amount of uncertainty in predicting 
future economic conditions. But the Fed's discretionary policy, 
even when expressed in terms of forward guidance, adds an 
additional layer of uncertainty for businesses and market 
participants to interpret how the Fed will react to the range 
of potential future economic conditions.
    Can you describe what benefits this additional layer of 
uncertainty via a discretionary policy, even with forward 
guidance, provides to the economy versus implementing a rules-
based approach? What are the advantages and risks of a 
discretionary monetary policy?

A.1. Similar to the basic principle underlying simple monetary 
policy rules, the Federal Open Market Committee (FOMC) follows 
a systematic approach in which it adjusts the stance of 
monetary policy in response to changes in the economic outlook. 
In its statement on ``Longer-Run Goals and Policy Strategy'', 
the FOMC clearly indicated how it interprets and measures the 
longer-run goals for monetary policy--maximum employment and 
stable prices--established by the Congress. \1\ Moreover, the 
statement notes that in conducting monetary policy, the FOMC 
seeks to minimize deviations of employment and inflation from 
these long-run objectives over time, by following a balanced 
approach. The Federal Reserve's policy actions over recent 
years have been fully consistent with this general approach to 
policy. Thus, while monetary policy does not follow a simple 
mathematical rule, the FOMC adjusts the stance of monetary 
policy in a systematic way in response to changes in the 
economic outlook. This approach to policy along with detailed 
FOMC communications regarding the likely path of short-term 
interest rates and the Federal Reserve's asset purchases helps 
the public to better understand the FOMC's ``reaction 
function,'' enhancing the effectiveness of monetary policy and 
providing the public with greater clarity about the FOMC's 
policy outlook and intentions.
---------------------------------------------------------------------------
     \1\ Statement on ``Longer-Run Goals and Policy Strategy'' can be 
found at: http://www.federalreserve.gov/rnonetarypolicy/files/
FOMC_LongerRunGoals.pdf.
---------------------------------------------------------------------------
    Of course, the FOMC regularly reviews the prescriptions of 
standard monetary policy rules for each meeting. While these 
rules are very useful in informing policy discussions, no 
simple policy rule could begin to capture the full range of 
complexities associated with determining the appropriate 
monetary policy response to the financial crisis and its 
aftermath. Indeed, there is no consensus among policymakers or 
economists about a particular monetary policy rule that would 
be appropriate across a wide variety of circumstances. Partly 
for these reasons, no central bank in the world sets policy 
simply by adhering to the prescriptions of a simple monetary 
policy rule.

Q.2. The Bank of International Settlements (BIS) 2014 annual 
report warned of the consequences of a long-term biased trend 
in central bank policymaking that tends to avoid tampering 
excesses during booms but remains highly accommodative during 
busts. The annual report states that central bank ``policy does 
not lean against the booms but eases aggressively and 
persistently during busts. This induces a downward bias in 
interest rates and an upward bias in debt levels, which in turn 
makes it hard to raise rates without damaging the economy--a 
debt trap.'' Relatedly, in an interview you gave to the New 
Yorker last month, you indicated that the Federal Reserve will 
maintain ``unusually accommodative'' monetary policy even after 
the economy recovers.
    Do you agree with the BIS's concern of uneven monetary 
policy approaches to booms and busts and the potential 
consequences on interest rates and debt levels? Would you agree 
that your stated plans to leave ``unusually accommodative'' 
policies intact even after the economy fully recovers could be 
indicative of BIS's contention of that central banks generally 
err towards easing?

A.2. As described in the FOMC's statement on ``Longer-Run Goals 
and Policy Strategy'', the FOMC conducts monetary policy so as 
to achieve its Congressionally established objectives of stable 
prices and maximum employment, taking a balanced approach to 
achieving both objectives over time. \2\ In the statement 
released after the September FOMC meeting, the FOMC indicated 
that it `` . . . currently anticipates that, even after 
employment and inflation are near mandate-consistent levels, 
economic conditions may, for some time, warrant keeping the 
target Federal funds rate below levels the FOMC views as normal 
in the longer run.'' \3\ The FOMC first added this language to 
its postmeeting statement after the March FOMC. The minutes of 
the March meeting note that meeting participants cited several 
reasons for their expectation that a lower-than-normal Federal 
funds rate may be necessary to achieve its dual mandate over 
time: `` . . . higher precautionary savings by U.S. households 
following the financial crisis, higher global levels of 
savings, demographic changes, slower growth in potential 
output, and continued restraint on the availability of 
credit.'' \4\
---------------------------------------------------------------------------
     \2\ The FOMC's statement on its longer run goals and policy 
strategy is renewed annually. The current version is available at 
http://www.federalreserve.gov/monetarypolicy/files/
FOMC_LongerRunGoals.pdf.
     \3\ http://www. federalreserve.gov/newsevents/press/monetary/
20140730a.htm
     \4\ http://www.federalreserve.gov/monetarypolicy/files/
fomcminutes20140319.pdf
---------------------------------------------------------------------------
    While several of these reasons are the consequence of the 
financial crisis, the FOMC's expectation that the Federal funds 
rate may need to be lower than normal for some time after 
inflation and employment return to mandate-consistent levels is 
not indicative of a bias toward easier policy over time. When 
asset price booms or excessively easy credit have in the past 
contributed to aggregate demand that was, or threatened to be, 
above levels consistent with achieving the dual mandate, the 
FOMC has tightened monetary policy in response. Indeed, if the 
FOMC were to conduct policy with a bias toward accommodation, 
then over time inflation would rise. Instead, inflation has 
fluctuated in a range around 2 percent--the FOMC's objective--
for the past 25 years.

Q.3. Interest payments on the debt are only slightly above the 
same levels they were 15 years ago in nominal terms ($415 
billion in 2013 versus $363 billion in 1998), despite the fact 
that our national debt is more than three times the size. 
Moreover, Fed remittances to the Treasury reduced the deficit 
by $77.7 billion last year, a figure that the Fed has projected 
could fall all the way to zero and deferring potential losses 
thereafter.
    Is there a medium to long term risk created by Fed policy 
untethering Treasury rates from natural market forces, allowing 
Congress to escape the true reality of the fiscal problems 
facing our country? Moreover, does the enormous size of our 
public debt have any influence on the Fed's interest rate 
policy or balance sheet size to hold down the Federal 
Government's external debt servicing costs. If it is not a 
current consideration, do you believe there is a possibility 
that the level of interest payments on the national debt could 
impact FOMC policy decisions in the future?

A.3. The Federal Reserve's accommodative policy is expressly 
designed to fulfill the dual mandates of maximum employment and 
price stability set for us by the Congress. Low interest rates 
are currently needed to help our economy grow at a faster rate 
and to provide support for a faster return to full employment 
than would otherwise occur.
    As interest rates rise, the Federal Reserve's net income, 
and thus its remittances to the Treasury, will decline from the 
unusually high levels seen in recent years. It is not likely 
that our remittances will fall to zero. However, that could 
happen if future economic conditions require appreciably larger 
or more rapid increases in interest rates than now seem likely. 
That said, it is highly likely that on average over time 
Federal Reserve remittances will be higher, not lower, as a 
result of our asset purchase programs.
    The goal of our monetary policy has been to foster outcomes 
consistent with our dual mandate, not to make gains on our 
balance sheet. We believe our policies have provided broad 
benefits to Americans--including higher employment and 
incomes--that are likely to dwarf any gains or losses on our 
portfolio. Moreover, while the direct fiscal impact of our 
purchases is likely to be modest, the fiscal impact of a 
stronger economy benefits all Americans.
    The responsibility for fiscal policy lies with the 
Administration and the Congress. The country does face 
important and serious fiscal challenges, but those challenges 
are primarily long-run in nature, and current interest rates 
should not be a major fiscal policy consideration as rates will 
certainly rise as the economic recovery continues. Prematurely 
raising interest rates could risk choking off the economic 
recovery and causing the Federal budget-deficit to deteriorate 
in the near term.

Q.4. There is evidence that the Basel II capital requirements 
helped fuel the European sovereign debt crisis by weighting 
sovereign debt as less risky than private debt. Citing concerns 
that European banks assess their home country's debt more 
favorably than they otherwise should and that in the aggregate 
banks assign a zero risk weight to more than half of their 
sovereign debt holdings, the Basel committee is reportedly 
considering a change in calculating the risk weighting of 
sovereign debt.
    Do you believe that current Basel III risk-weighting rules 
appropriately treat sovereign debt? Do you believe the 
existence of any security or instrument with a zero risk 
weighting for capital standards promotes a sound global 
financial system? Does the favorable regulatory capital 
treatment of sovereign debt act as a subsidy to Governments to 
live outside their means?

A.4. The U.S. banking agencies' regulatory capital rules 
(capital rules) enhance the ability of banking organizations to 
consistently function as financial intermediaries, particularly 
during periods of economic and financial stress. The capital 
requirements under the capital rules were designed to reflect 
banking organizations' risk profiles.
    With regard to sovereign exposures, the treatment under the 
Basel Accord is to assign risk weights between zero and 150 
percent based on either the (a) external credit ratings 
assigned by a credit rating agency (e.g., Standard & Poor's), 
or (b) credit assessments assigned by an export credit agency 
(e.g., the Organization for Economic Cooperation and 
Development (OECD)). There is international work underway in 
which the United States participates that seeks to reduce 
mechanistic reliance on credit ratings. Overreliance on credit 
ratings was shown to be a major contributor to the financial 
crisis, as credit rating agencies underestimated the risk of 
certain asset categories, including sovereigns, and banks did 
not possess a full understanding of the risk profile of the 
assets they owned.
    Domestically, in response to the Dodd-Frank Wall Street 
Reform and Consumer Protection Act (Dodd-Frank Act) requirement 
to remove external credit ratings from U.S. Federal 
regulations, the U.S. banking agencies developed alternatives 
to credit ratings for certain types of exposures, including 
exposures to sovereigns. The capital rule's standardized 
approach provides for a risk sensitive treatment of sovereign 
debt that is based on the Country Risk Classification (CRC) 
assigned by the OECD.
    Under the capital rules, only the sovereign debt of certain 
high-income and OECD member countries, such as Japan, 
Singapore, Germany, and the United Kingdom, receive a zero 
percent risk weight. The sovereign debt of other countries can 
receive risk weights between 20 and 150 percent, depending on 
their CRC rating. The sovereign debt of countries that have 
defaulted or restructured their debt within the last 5 years 
(e.g., Argentina and Greece), receive the more punitive risk 
weight of 150 percent.
    In addition, the U.S. banking agencies' capital rules 
require that banking organizations meet a minimum leverage 
ratio under which all assets are effectively risk weighted at 
100 percent. The leverage ratio requirement complements the 
risk-based capital standards and ensures that the agencies' 
overall capital framework assesses capital against all assets.

Q.5. The June FOMC minutes indicate the Fed is still 
contemplating how to handle the rolling over of maturing 
securities following the completion of QE3. When do you 
anticipate the FOMC will discontinue the rollovers and what 
factors will go into the Fed's reinvestment policy decision?

A.5. As discussed in the September FOMC statement on ``Policy 
Normalization Principles and Plans'', the FOMC intends to 
reduce the Federal Reserve's securities holdings in a gradual 
and predictable manner primarily by ceasing to reinvest 
repayments of principal on securities held in the System Open 
Market Account (SOMA) portfolio. The FOMC expects to cease or 
commence phasing out reinvestments after it begins increasing 
the target range for the Federal funds rate; the timing will 
depend on how economic and financial conditions and the 
economic outlook evolve. All of the FOMC's policy actions are 
directed toward fostering its macroeconomic objectives of 
maximum employment and stable prices. In judging the 
appropriate timing of various aspects of its normalization 
strategy including the decision to cease reinvestments, the 
FOMC will, as always, review a wide range of information on 
labor market conditions, inflation developments, and conditions 
in financial markets.

Q.6. The Federal Reserve Office of Inspector General has issued 
two reports detailing concerns with the management and 
associated costs of the Martin Building project. During the 
more than 10 years of planning and design, this project has had 
an alarming number of delays and cost increases prior to even 
reaching the construction phase. As of September 2012, the 
Martin Building project is expected to cost $280.4 million 
dollars, including $179.9 million for the renovation of the 
Martin Building and the construction of a visitors' center and 
conference center. Can you please provide the following 
information related to the Martin Building project:

  1.  A copy of all of the contracts and modifications 
        associated with the design and construction for the 
        building that have been awarded to date, as well as a 
        copy of the deliverables provided under each one.

  2.  A specific and detailed time line of all the Board's 
        actions related to the Martin Building project through 
        the anticipated completion date.

  3.  The total amount of fees incurred by modifications to the 
        original design contract.

  4.  An update of the total claims paid by the Board to Karn 
        Charuhas Chapman & Twohey (KCCT) for the increased 
        costs in the hourly labor rates incurred due to 
        extending the A/E contract from the originally 
        anticipated July 12, 2007, completion date to the now 
        expected completion date of April 2015 (included on p. 
        4 of OIG Report No. 2013-AA-B-007).

  5.  The most recent cost projection for the Martin Building 
        project, with a break out of the construction cost and 
        square footage estimates for each of the components 
        associated with the project (the Martin Building 
        renovation, the visitors' center, and the conference 
        center).

  6.  All documents related to the analysis and final decision 
        of ``a range of options for the approach to the Martin 
        Building renovations proposed by the Board's project 
        team'' initiated in October 2011 that was cited on p. 3 
        in OIG Report No. 2013-AA-B-007.

  7.  The basis for the $76.7 million line-item for leased 
        space in the September 2012 Martin project cost 
        projection and factors that will be considered when 
        seeking temporary lease space.

  8.  A comprehensive plan for the Board to mitigate similar 
        cost overruns during the construction phase of the 
        Martin Building project.

A.6. Response to Question 6, parts 1-8.
    As you know, the Federal Reserve Board (Board) is planning 
a complete renovation of the William McChesney Martin, Jr., 
building (Martin building). The project will also include 
construction of visitor screening and conference center 
additions to the building. The Martin building was constructed 
in 1974 and has not undergone significant renovation since its 
construction. The building is structurally connected to the 
Board's historic Marriner S. Eccles building (Eccles building). 
Normal wear-and-tear, equipment obsolescence, changes in 
building code, and accessibility issues have resulted in a 
backlog of deficiencies that require a comprehensive building 
renovation. In particular, the existing heating, ventilation, 
and air conditioning system can no longer provide effective and 
energy efficient temperature and humidity control. 
Additionally, the plumbing, mechanical, and electrical systems 
are not compliant with current code and need updating to fully 
support current information technology, life safety, and 
security requirements. The project will also include the 
removal of asbestos. The renovation is unique in that a number 
of significant security updates will be included within the 
scope of the project in response to vulnerability assessments 
provided to the Board. For instance, a security screening 
center will be added that will centralize, improve, and 
increase efficiency and effectiveness of security screening of 
those entering both the Eccles and Martin buildings. The 
conference center additions will reduce reliance on offsite, 
nonsecure, leased conference facilities. The conference center 
will also include a press briefing room to accommodate the 
Chair's press conferences, which have unique security needs and 
are an integral part of the Board's ongoing transparency 
initiative.
    The Board had internal discussions regarding the concept 
for this renovation in 2001, and researched the potential scope 
and cost estimates for a renovation in the years following 
2001. However, the Board did not begin design work for the 
renovation until late 2006, when the Board competitively 
awarded a contract to an architectural/engineering firm, Karn 
Charuhas Chapman & Twohey (KCCT), to design only a visitor 
screening and conference center for the building. At this point 
in time the Board was not considering renovating the entire 
building. Starting in 2007, Board staff visited various Federal 
Reserve Banks to investigate how they had designed and utilized 
visitor screening and conference centers in order to inform the 
Board's design.
    Shortly thereafter, events related to the financial crisis 
began to arise. During the crisis and for the next several 
years, the Board and its senior staff shifted their focus away 
from the building renovation towards addressing the matters 
raised by the financial crisis and its aftermath. Some elements 
of the conceptual design for the visitor screening and 
conference center did progress amidst the crisis, such as 
conducting the required National Environmental Policy Act 
(NEPA) study for the space and seeking the required approvals 
from the National Capital Planning Commission (NCPC) and the 
U.S. Commission of Fine Arts (CFA). However, the overall pace 
of the design process slowed significantly in light of the 
financial crisis.
    Following the Board's determination that a full renovation 
would be more cost effective than continuing to incrementally 
repair the building's aging structure and systems, in February 
2011, the Board modified its contract with KCCT to include the 
design for a full renovation of the Martin building.
    As the Board began planning for the renovation, it became 
clear that integrating plans to address the long-term needs for 
the building with plans to make broader organizational changes 
was necessary to make the design and renovation process as 
economical and practical as possible. Thus, the Board addressed 
its full building needs as part of its strategic plan. This 
process revealed, for example, that the Board's operations 
would be more efficient and resilient if the Board's data 
center was relocated out of the Martin building. The Board 
expects to complete the construction work related to the data 
center relocation by the end of 2014. In addition, the Board is 
planning to complete the design process for the renovation of 
the Martin building by mid-2015. The Board intends to solicit 
and competitively award a general construction contract for the 
renovation in the third quarter of 2015. The Board's target is 
to substantially complete construction in the second half of 
2018.
    The Board appreciates that it is undertaking a substantial 
project and has implemented a variety of cost management 
measures to control the renovation expenses. For example, the 
Board is going to hire a qualified, competent general 
contractor (GC) for construction of the renovation project who 
is well experienced in projects of similar scope, size, and 
complexity. This will help ensure that the project stays on 
budget and on schedule. A multistep, best value solicitation 
and competitive award process is planned for selecting the GC 
on a firm-fixed-price basis. Technical qualifications will be 
solicited from various GC firms as a first step. The GCs will 
be required to demonstrate extensive experience in projects of 
similar scope, size, and complexity. The GCs will also be asked 
to provide details regarding schedule achievement, change order 
and claims history, and any cost overruns in their prior 
projects. A selection panel comprised of personnel from the 
Board's space planning, construction management, budgeting, and 
procurement teams will evaluate the GCs'-technical 
qualification materials. Finally, the Board will retain the 
right to issue separate contracts for discrete elements of the 
project, where it could be favorable for the Board to manage a 
separate contract from a procurement, cost, schedule, or 
management perspective.
    The GC will be required to provide a 1-year warranty on the 
construction work performed. This will be in addition to any 
extended warranty periods for systems and products identified 
in the contract documents. Ten months after final completion of 
the renovation project, a comprehensive walk-through will be 
conducted, including participation by Board staff, KCCT, and 
the Board's construction administrator and commissioning agent, 
to verify that all building systems are functioning properly. A 
final list of any required corrective actions will be provided 
to the GC for correction prior to the expiration of the GC's 
warranty period.
    The Board also has several internal oversight committees in 
place to supervise specific aspects of the renovation based on 
the staffs' relevant areas of expertise. These committees are 
comprised of senior staff from the Board's procurement, 
facilities, and financial management functions, all of whom 
report to, and are overseen by, the Board's Chief Operating 
Officer and Administrative Governor.
    On the design side, KCCT's firm-fixed-price contract 
requires them to design the renovations in a manner that does 
not exceed the cost limit for the project established under the 
design contract. KCCT must also develop design alternatives if 
their original design does not meet the Board's stated cost 
limit. These alternatives will afford the Board flexibility to 
adjust the project scope of work to align with the Board's cost 
limit should bid results differ from cost estimate 
expectations. In developing the Board's cost limit for the 
project, the Board and KCCT each retained consultants to 
provide independent professional cost estimates for the 
renovation. These two consultants have both verified that the 
project can be constructed within the cost limit set by the 
Board.
    The Board announced a budget of $280.4 million for the 
renovation project in its Annual Performance Report 2012. This 
budget includes a $76.7 million line-item for the estimated 
cost to lease swing space, as further discussed below. The 
Board is in the process of undertaking its contracting for the 
renovation project and is striving to achieve a total project 
cost that is less than the budgeted amount.
    Due to the extent of the renovations, the Board determined 
that it will be more cost effective to relocate Board employees 
to swing space during the renovation project rather than to 
undertake the project on a floor-by-floor or other similar 
phased basis. The Board's project budget, established in 2012, 
includes a $76.7 million line-item for the estimated cost to 
lease space for up to 5 years to accommodate the relocated 
employees during the renovation. This estimated cost of leasing 
space includes rent, furniture and equipment, security, 
information technology, moving expenses, and depreciation 
related to the interior construction within the leased space. 
The Board actually negotiated a lower rental rate for the swing 
space than originally budgeted and now anticipates that the 
costs for the leased swing space during the renovation project 
will be approximately $72.6 million. The Board will begin 
moving personnel into the leased space in early 2015. The Board 
considered many factors in seeking temporary leased space, such 
as the ability to meet the Board's space requirements, 
proximity to the Board's current owned buildings and leased 
spaces, proximity to public transportation (e.g., commuter 
buses, subway, rail), the financial comparison of different 
leased space options and scenarios on a net present value (NPV) 
basis, the financial impacts to the Board's current and future 
operating budgets, and contiguity of floors and spaces 
available.
    You have also asked for information regarding modifications 
to the Board's design contract with KCCT. As noted in the time 
line above, the Board initially contracted with KCCT in 2006 
for the design of only a visitor screening and conference 
center for the building, and not for a full renovation of the 
building. When the Board determined that renovation of the 
entire building was needed, the Board modified its contract 
with KCCT in 2011 to reflect the substantial increase in the 
scope of the design work. This was a significant contract 
modification and accounts for the largest increase in the 
contract fees. The decision to proceed with the full building 
renovation also resulted in the need to extend the term of 
KCCT's contract to reflect the completion of design in 2015. A 
table which provides detail on all modifications to the KCCT 
contract, including the total costs incurred, is attached.
    You also requested copies of several documents, such as a 
copy of all contracts issued to date for the Martin building 
design and construction and the documents related to the 
``range of options for the approach to the Martin building 
renovations proposed by the Board's project team'' initiated in 
October 2011. These documents are enclosed. Some portions of 
the enclosed documents have been withheld because they contain 
sensitive information regarding security features that, if 
disclosed in this public response, would jeopardize the 
security features they are intended to provide. Other portions 
have been redacted to avoid competitive harm, either to a party 
who holds an existing contract with the Board (the economic 
details of which, if made public, would allow competitors to 
gain an unfair advantage into the party's business practices) 
or to the Board's competitive bid process (as noted previously, 
a contract has not yet been awarded for the construction of the 
renovations). Un-redacted copies of these documents are 
available for inspection here at the Board. Finally, please 
note that the documents related to the ``range of options for 
the approach to the Martin building renovations proposed by the 
Board's project team'' reflect staff analysis and were prepared 
at the staff level in order to assist the Governors as they 
considered whether or not the Board should go forward with the 
full building renovation. Thus, this document does not 
necessarily reflect the views of the Board members.
    We will make all other documents available for your 
inspection here at the Board. The deliverables under the design 
contracts contain sensitive information regarding security 
features. The contract deliverables also include architectural 
and engineering drawings which are quite voluminous and not 
easily reproduced.


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Contract for architectural and engineering design services between the 
        Board of Governors of the Federal Reserve System and Karn 
        Charuhas Chapman & Twohey, PC dated October 23, 2006
        
        
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