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61–513 PDF 2010

S. HRG. 111–772 

FEDERAL RESERVE’S FIRST MONETARY POLICY 

REPORT FOR 2010 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED ELEVENTH CONGRESS 

SECOND SESSION 

ON 

RECEIVING THE FEDERAL RESERVE’S SEMI-ANNUAL MONETARY REPORT TO THE CONGRESS AND DISCUSSING MONETARY POLICY AND 

THE ECONOMIC OUTLOOK 

FEBRUARY 25, 2010 

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

( 

Available at: http://www.access.gpo.gov/congress/senate/senate05sh.html 
COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS 

CHRISTOPHER J. DODD, Connecticut, Chairman 

TIM JOHNSON, South Dakota 

JACK REED, Rhode Island 

CHARLES E. SCHUMER, New York 

EVAN BAYH, Indiana 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

JON TESTER, Montana 

HERB KOHL, Wisconsin 

MARK R. WARNER, Virginia 

JEFF MERKLEY, Oregon 

MICHAEL F. BENNET, Colorado 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

BOB CORKER, Tennessee 

JIM DEMINT, South Carolina 

DAVID VITTER, Louisiana 

MIKE JOHANNS, Nebraska 

KAY BAILEY HUTCHISON, Texas 

JUDD GREGG, New Hampshire 

EDWARD SILVERMAN, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director and Counsel 

MARC JARSULIC, Chief Economist 

DREW COLBERT, Legislative Assistant 

MISHA MINTZ-ROTH, Legislative Assistant 

LISA FRUMIN, Legislative Assistant 

MARK OESTERLE, Republican Chief Counsel 

JEFF WRASE, Republican Chief Economist 

ANDREW OLMEM, Republican Senior Counsel 

CHAD DAVIS, Republican Professional Staff Member 

RHYSE NANCE, Republican Professional Staff Member 

LAURA SWANSON, Professional Staff Member 

KARA STEIN, Professional Staff Member 

DAWN RATLIFF, Chief Clerk 

LEVON BAGRAMIAN, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

(II)
C O N T E N T S 

THURSDAY, FEBRUARY 25, 2010 

Page 

Opening statement of Chairman Dodd .................................................................. 1 

Opening statements, comments, or prepared statement of: 

Senator Shelby .................................................................................................. 3 

WITNESSES 

Ben S. Bernanke, Chairman, Board of Governors of the Federal Reserve 

System ................................................................................................................... 4 

Prepared statement .......................................................................................... 50 

Response to written questions of: 

Senator Shelby ........................................................................................... 109 

Senator Brown ........................................................................................... 117 

Senator Merkley ........................................................................................ 122 

Senator Bunning ....................................................................................... 125 

(III)

(1) 

FEDERAL RESERVE’S FIRST MONETARY 

POLICY REPORT FOR 2010 

THURSDAY, FEBRUARY 25, 2010 

U.S. SENATE, COMMITTEE ON BANKING, HOUSING, AND URBAN AFFAIRS, Washington, DC. 

The Committee met at 9:08 a.m. in room SD–538, Dirksen Senate Office Building, Senator Christopher J. Dodd, Chairman of the 

Committee, presiding. 

OPENING STATEMENT OF CHAIRMAN CHRISTOPHER J. DODD 

Chairman DODD. The Committee will come to order. 

Let me welcome all who are here this morning for the Committee 

hearing, the hearing on the semiannual monetary report to Congress by the Chairman of the Federal Reserve, and we welcome you 

once again, Mr. Chairman, to the Banking Committee. I will make 

a brief opening statement, turn to Senator Shelby for any comments he may make, and then we will turn right to you for your 

opening comments and get to some questioning. But we thank you 

once again for joining us here this morning. 

Today, as you testify before us, Mr. Chairman, it is worth taking 

a moment to recognize that our economy is showing signs of emerging from this recession. During the last two quarters, GDP has 

shown positive growth, as has gross private domestic investment, 

and financial markets have stabilized enough to allow the Fed to 

wind down nearly all the liquidity facilities it established in response to this crisis. 

But that does not mean, of course, that our economy is out of the 

woods, as we all know. And more importantly, it does not mean 

that the situation of working families has improved dramatically 

either. Households and small businesses dependent on banks for financing continue to have trouble getting the loans that they need. 

Commercial real estate losses continue to mount, and combined 

with losses on home mortgages, they are making the credit crunch 

even worse. 

Outside of securities guaranteed by the Federal Government, the 

residential and commercial markets for mortgage-backed securities 

are practically non-existent. Foreclosures continue to plague our 

communities at greater and greater rates, and the large inventory 

of foreclosed homes continues to suppress the housing market and 

discouraging new construction. 

And worst of all, Mr. Chairman, the job market continues to suffer from the losses incurred during the recession. We have lost 8.4 

million jobs since December of 2007. The unemployment rate 
2 

stands at 9.7 percent, although many of us would argue here that 

that number is actually vastly in excess of that in many areas of 

the country. And it is widely expected that it will remain high for 

several years to come. An astonishing 6.3 million American workers have been out of a job for a half a year or more, and that is 

a record in our Nation. 

The state of our economy as a whole may be improving, but if 

we are talking about the situation of ordinary American families, 

I think I can sum up this recovery in three words: Not good 

enough. I think most would agree. 

The longer we go without resolving these problems, the worse off, 

of course, we all will be. Unemployed Americans will continue to 

lose their health insurance and their homes. Their skills will begin 

to deteriorate, leaving us less competitive in the global economy. 

Those who do have jobs will see their wages stagnate. Our country 

will suffer as a result. 

This Congress has a role to play in putting people back to work, 

and we have a responsibility to put protections in place to make 

sure that a crisis like this never threatens our financial system 

again. Our Committee has made important progress toward that 

end, and my hope is that we will have a financial reform bill ready 

in the coming days. 

Mr. Chairman, you also have a role to play in all of this, as you 

know, and I have been impressed by your leadership, keeping the 

American economy from falling into the abyss, and you deserve a 

great deal of credit, in my view, for having contributed so significantly to that result. But now it is time as well, as I am sure you 

will agree, for you to show the same kind of leadership in helping 

us and American families along with those of us on this side of the 

dais to achieve the same fate, to come out of this abyss and get 

back on our feet again. 

So I look forward to working with you in the coming days—I 

know all of my colleagues will—work on your ideas and how monetary policy can help our constituents emerge from this recession. 

Now, as many of my colleagues know, having filled in the seat 

for Ted Kennedy as Chairman of the Health, Education, and Labor 

Committee, I have another place to be this morning—at the White 

House—to sit there and resolve health care, which I am confident 

we are going to do this morning, I would say to my colleagues. I 

do not see any smiles around the table on hearing that prediction. 

And so I am going to be leaving shortly, but I want to take—I am 

going to abuse my chairmanship for a minute. I am going to ask 

you a question because I will not get a chance in the normal process. 

In light of what is happening in Greece, Mr. Chairman, I wanted 

to raise an issue because matters have arisen, and I will raise this 

and you can either respond quickly to it and I will go right to Senator Shelby. But if I indulge my colleagues by doing this—I have 

not done this before, but given that I have got the problems this 

morning where I have to be. 

The debt crisis, Mr. Chairman, in Greece is shedding light on the 

role of derivatives in the financial markets. According to news reports this morning and over the last several days, banks and hedge 

funds are using credit default swaps to bet that Greece will default 
3 

on its debt. The rising price of these contracts contributes to an atmosphere of crisis, making it even more difficult for the Greek Government, in my opinion, to borrow. Since there is no requirement 

that purchasers of credit default swaps actually own any of the underlying debt, we have a situation in which major financial institutions are amplifying a public crisis for what would appear to be private gain. 

I want to ask you here whether or not you think there ought to 

be limits on the use of credit default swaps to prevent the intentional creation of runs against governments. Do you have any quick 

comments on that? 

Mr. BERNANKE. Yes, Senator. I just want to say first of all that 

we are looking into a number of questions related to Goldman 

Sachs and other companies and their derivatives arrangements 

with Greece and on this issue as well. As you know, credit default 

swaps are properly used as hedging instruments. 

Chairman DODD. I agree. 

Mr. BERNANKE. The SEC, of course, has been interested in this 

issue. Obviously, using these instruments in a way that intentionally destabilizes a company or a country is counterproductive, 

and I am sure the SEC will be looking into that. We will certainly 

be evaluating what we can learn from the activities of the holding 

companies that we supervise here in the United States. 

Chairman DODD. Well, let me just make the request of you here, 

and we will make the similar request to the SEC. I am sure all of 

us on this Committee would like to hear very quickly what the response is going to be, if any, either from your or recommendations 

you would make as well as from the SEC. I will make that formal 

request this morning. I think it is a critical issue for all of us. 

Senator Shelby. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you. Thank you, Chairman Dodd. Welcome to the Committee, Chairman Bernanke, again. 

As our financial markets began to show signs of improvement, 

many of the Fed’s temporary lending facilities have been allowed 

to expire, and monetary policy has begun to normalize. And while 

use of the temporary lending facilities wane, expanded purchases 

by the Fed of Federal agency debt, mortgage-backed securities, and 

longer-term Treasury securities have kept the size of the Fed’s balance sheet unusually large. 

As of last week, it is my understanding that the banks had over 

$1.2 trillion in reserve balances at Federal Reserve banks. That is 

more than 100 times the average level of such balances in 2006. 

This morning I am interested in hearing, Mr. Chairman, plans 

for reducing the size of the Fed’s balance sheet, withdrawing extraordinary liquidity support from the banking system, and continuing the normalization of monetary policy. In addition, I believe, 

Mr. Chairman, you should tell us how the Fed plans to use interest 

on reserves as a monetary policy tool and how you intend to use 

reverse repurchase agreements to address reserves in the banking 

system. 

Finally, the Committee, I believe, should gain a better understanding of how the Fed and the Treasury Department intend to 
4 

manage the Fed’s balance sheet, and I think this is especially relevant given Tuesday’s announcement by the Treasury that it anticipates selling securities and injecting around $200 billion into 

the Department’s supplemental financing account at the Fed over 

the next 2 months. 

Mr. Chairman, while there are signs of improvement in the economy, conditions remain weak, especially in labor markets. Too 

many Americans are unemployed or underemployed. Because credible plans for fiscal balance and monetary policy are essential for 

economic recovery, we need to have transparency and clarity about 

the Federal Reserve’s plans. My hope this morning, Mr. Chairman, 

is that you will provide that clarity. 

Thank you. 

Chairman DODD. Mr. Chairman, the floor is yours. 

STATEMENT OF BEN S. BERNANKE, CHAIRMAN, BOARD OF 

GOVERNORS OF THE FEDERAL RESERVE SYSTEM 

Mr. BERNANKE. Thank you. Chairman Dodd, Ranking Member 

Shelby, and other members of the Committee, I am pleased to 

present the Federal Reserve’s semiannual Monetary Policy Report 

to the Congress. I will begin today with some comments on the outlook for the economy and for monetary policy and then touch briefly on several important issues. 

Although the recession officially began more than 2 years ago, 

U.S. economic activity contracted particularly sharply following the 

intensification of the global financial crisis in the fall of 2008. Concerted efforts by the Federal Reserve, the Treasury Department, 

and other U.S. authorities to stabilize the financial system, together with highly stimulative monetary and fiscal policies, helped 

arrest the decline and are supporting a nascent economic recovery. 

Indeed, the U.S. economy expanded at about a 4-percent annual 

rate during the second half of last year. A significant portion of 

that growth, however, can be attributed to the progress that firms 

made in working down unwanted inventories of unsold goods, 

which left them more willing to increase production. As the impetus provided by the inventory cycle is temporary, and as the fiscal 

support for economic growth likely will diminish later this year, a 

sustained recovery will depend on continued growth in private sector final demand for goods and services. 

Private final demand does seem to be growing at a moderate 

pace, buoyed in part by a general improvement in financial conditions. In particular, consumer spending has recently picked up, reflecting gains in real disposable income and household wealth and 

tentative signs of stabilization in the labor market. Business investment in equipment and software has risen significantly. And 

international trade—supported by a recovery in the economies of 

many of our trading partners—is rebounding from its deep contraction of a year ago. However, starts of single-family homes, which 

rose noticeably this past spring, have recently been roughly flat, 

and commercial construction is declining sharply, reflecting poor 

fundamentals and continued difficulty in obtaining financing. 

The job market has been especially hard hit by the recession, as 

employers reacted to sharp sales declines and concerns about credit 

availability by deeply cutting their workforces in late 2008 and in 
5 

2009. Some recent indicators suggest that the deterioration in the 

labor market is abating: Job losses have slowed considerably, and 

the number of full-time jobs in manufacturing rose modestly in 

January. Initial claims for unemployment insurance have continued to trend lower, and the temporary services industry, often considered a bellwether for the employment outlook, has been expanding steadily since October. Notwithstanding these positive signs, 

the job market remains quite weak, with the unemployment rate 

near 10 percent and job openings scarce. Of particular concern, because of its long-term implications for workers’ skills and wages, is 

the increasing incidence of long-term unemployment; indeed, more 

than 40 percent of the unemployed have been out of work for 6 

months or more, nearly double the share of a year ago. 

Increases in energy prices resulted in a pickup in consumer price 

inflation in the second half of last year, but oil prices have flattened out over recent months, and most indicators suggest that inflation will likely remain subdued for some time. Slack in labor and 

product markets has reduced wage and price pressures in most 

markets, and sharp increases in productivity have further reduced 

producers’ unit labor costs. The cost of shelter, which receives a 

heavy weight in consumer price indexes, is rising very slowly, reflecting high vacancy rates. In addition, according to most measures, longer-term inflation expectations have remained relatively 

stable. 

The improvement in financial markets that began last spring 

continues. Conditions in short-term funding markets have returned 

to near pre-crisis levels. Many (mostly larger) firms have been able 

to issue corporate bonds or new equity and do not seem to be hampered by a lack of credit. In contrast, bank lending continues to 

contract, reflecting both tightened lending standards and weak demand for credit amid uncertain economic prospects. 

In conjunction with the January meeting of the FOMC, Board 

members and Reserve Bank presidents prepared projections for 

economic growth, unemployment, and inflation for the years 2010 

through 2012 and over the longer run. The contours of these forecasts are broadly similar to those I reported to the Congress last 

July. FOMC participants continue to anticipate a moderate pace of 

economic recovery, with economic growth of roughly 3 to 3 1⁄2 percent in 2010 and 3 1⁄2 to 4 1⁄2 percent in 2011. Consistent with moderate economic growth, participants expect the unemployment rate 

to decline only slowly, to a range of roughly 6 1⁄2 to 7 1⁄2 percent by 

the end of 2012, still well above their estimate of the long-run sustainable rate of about 5 percent. Inflation is expected to remain 

subdued, with consumer prices rising at rates between 1 and 2 percent in 2010 through 2012. In the longer term, inflation is expected 

to be between 1 3⁄4 and 2 percent, the range that most FOMC participants judge to be consistent with the Federal Reserve’s dual 

mandate of price stability and maximum employment. 

Over the past year, the Federal Reserve has employed a wide 

array of tools to promote economic recovery and preserve price stability. The target for the Federal funds rate has been maintained 

at a historically low range of 0 to 1⁄4 percent since December 2008. 

The FOMC continues to anticipate that economic conditions—including low rates of resource utilization, subdued inflation trends, 
6 

and stable inflation expectations—are likely to warrant exceptionally low levels of the Federal funds rate for an extended period. 

To provide support to mortgage lending and housing markets and 

to improve overall conditions in private credit markets, the Federal 

Reserve is in the process of purchasing $1.25 trillion of agency 

mortgage-backed securities and about $175 billion of agency debt. 

We have been gradually slowing the pace of these purchases in 

order to promote a smooth transition in markets and anticipate 

that these transactions will be completed by the end of March. The 

FOMC will continue to evaluate its purchases of securities in light 

of the evolving economic outlook and conditions in financial markets. 

In response to the substantial improvements in the functioning 

of most financial markets, the Federal Reserve is winding down the 

special liquidity facilities it created during the crisis. On February 

1, a number of these facilities, including credit facilities for primary 

dealers, lending programs intended to help stabilize money market 

mutual funds and the commercial paper market, and temporary liquidity swap lines with foreign central banks, were all allowed to 

expire. 

The only remaining lending program for multiple borrowers created under the Federal Reserve’s emergency authorities, is the 

Term Asset-Backed Securities Loan Facility, or TALF, and it is 

scheduled to close on March 31 for loans backed by all types of collateral except for newly issued commercial mortgage-backed securities, and it will close on June 30 for loans backed by newly issued 

CMBS. 

In addition to closing its special facilities, the Federal Reserve is 

normalizing its lending to commercial banks through the discount 

window. The final auction of discount window funds to depositories 

through the Term Auction Facility, which was created in the early 

stages of the crisis to improve the liquidity of the banking system, 

will occur on March 8. Last week, we announced the maximum 

term of discount window loans, which was increased to as much as 

90 days during the crisis, would be returned to overnight for most 

banks, as it was before the crisis erupted in August 2007. 

To discourage banks from relying on the discount window rather 

than private funding markets for short-term credit, last week we 

also increased the discount rate by 25 basis points, raising the 

spread between the discount rate and the top of the target range 

for the Federal funds rate to 50 basis points. These changes, like 

the closure of most of the special lending facilities earlier this 

month, are in response to the improved functioning of financial 

markets, which has reduced the need for extraordinary assistance 

from the Federal Reserve. These adjustments are not expected to 

lead to tighter financial conditions for households and businesses 

and should not be interpreted as signaling any change in the outlook for monetary policy, which remains about the same as it was 

at the time of the January meeting of the FOMC. 

Although the Federal funds rate is likely to remain exceptionally 

low for an extended period, as the expansion matures, the Federal 

Reserve will at some point need to begin to tighten monetary conditions to prevent the development of inflationary pressures. Notwithstanding the substantial increase in the size of its balance 
7 

sheet associated with its purchases of Treasury and agency securities, we are confident that we have the tools we need to firm the 

stance of monetary policy at the appropriate time. 

Most importantly, in October 2008 the Congress gave statutory 

authority to the Federal Reserve to pay interest on banks’ holdings 

of reserve balances at Federal Reserve banks. By increasing the interest rate on reserves, the Federal Reserve will be able to put significant upward pressure on all short-term interest rates. Actual 

and prospective increases in short-term interest rates will be reflected in turn in longer-term interest rates and in financial conditions more generally. 

The Federal Reserve has also been developing a number of additional tools to reduce the large quantity of reserves held by the 

banking system, which will improve the Federal Reserve’s control 

of financial conditions by leading to a tighter relationship between 

the interest rate paid on reserves and other short-term interest 

rates. Notably, our operational capacity for conducting reverse repurchase agreements, a tool that the Federal Reserve has historically used to absorb reserves from the banking system, is being expanded so that such transactions can be used to absorb large quantities of reserves. The Federal Reserve is also currently refining 

plans for a term deposit facility that could convert a portion of depository institutions’ holdings of reserve balances into deposits that 

are less liquid and could not be used to meet reserve requirements. 

In addition, the FOMC has the option of redeeming or selling securities as a means of reducing outstanding bank reserves and applying monetary restraint. Of course, the sequencing of steps and the 

combination of tools that the Federal Reserve uses as it exits from 

its currently very accommodative policy stance will depend on economic and financial developments. I provided more discussion of 

these options and possible sequencing in a recent testimony. 

The Federal Reserve is committed to ensuring that the Congress 

and the public have all the information needed to understand our 

decisions and to be assured of the integrity of our operations. Indeed, on matters related to the conduct of monetary policy, the 

Federal Reserve is already one of the most transparent central 

banks in the world, providing detailed records and explanations of 

its decisions. Over the past year, the Federal Reserve also took a 

number of steps to enhance the transparency of its special credit 

and liquidity facilities, including the provision of regular, extensive 

reports to the Congress and the public; and we have worked closely 

with the GAO, the SIGTARP, the Congress, and private sector 

auditors on a range of matters relating to these facilities. 

While the emergency credit and liquidity facilities were important tools for implementing monetary policy during the crisis, we 

understand that the unusual nature of those facilities creates a 

special obligation to assure the Congress and the public of the integrity of their operation. Accordingly, we would welcome a review 

by the GAO of the Federal Reserve’s management of all facilities 

created under emergency authorities. In particular, we would support legislation authorizing the GAO to audit the operational integrity, collateral policies, use of third-party contractors, accounting, 

financial reporting, and internal controls of these special liquidity 

and credit facilities. The Federal Reserve will, of course, cooperate 
8 

fully and actively in all reviews. We are also prepared to support 

legislation that would require the release of the identities of the 

firms that participated in each special facility after an appropriate 

delay. It is important that the release occur after a lag that is sufficiently long that investors will not view an institution’s use of one 

of these facilities as a possible indication of ongoing financial problems, thereby undermining market confidence in the institution or 

discouraging use of any future facility that might become necessary 

to protect the U.S. economy. An appropriate delay would also allow 

firms adequate time to inform investors through annual reports 

and other public documents of their use of Federal Reserve facilities. 

Looking ahead, we will continue to work with the Congress in 

identifying approaches for enhancing the Federal Reserve’s transparency that are consistent with our statutory objectives of fostering maximum employment and price stability. In particular, it 

is vital that the conduct of monetary policy continue to be insulated 

from short-term political pressures so that the FOMC can make 

policy decisions in the longer-term economic interests of the American people. Moreover, the confidentiality of discount window lending to individual depository institutions must be maintained so 

that the Federal Reserve continues to have effective ways to provide liquidity to depository institutions under circumstances where 

other sources of funding are not available. The Federal Reserve’s 

ability to inject liquidity into the financial system is critical for preserving financial stability and for supporting depositories’ key role 

in meeting the ongoing credit needs of firms and households. 

Strengthening our financial regulatory system is essential for the 

long-term economic stability of the Nation. Among the lessons of 

the crisis are the crucial importance of macroprudential regulation 

that is, regulation and supervision aimed at addressing risks to the 

financial system as a whole—and the need for effective consolidated supervision of every financial institution that is so large or 

interconnected that its failure could threaten the functioning of the 

entire financial system. 

The Federal Reserve strongly supports the Congress’ ongoing efforts to achieve comprehensive financial reform. In the meantime, 

to strengthen the Federal Reserve’s oversight of banking organizations, we have been conducting an intensive self-examination of our 

regulatory and supervisory responsibilities and have been actively 

implementing improvements. For example, the Federal Reserve has 

been playing a key role in international efforts to toughen capital 

and liquidity requirements for financial institutions, particularly 

systemically critical firms, and we have been taking the lead in ensuring that compensation structures at banking organizations provide appropriate incentives without encouraging excessive risk taking. 

The Federal Reserve is also making fundamental changes in its 

supervision of large, complex bank holding companies, both to improve the effectiveness of consolidated supervision and to incorporate a macroprudential perspective that goes beyond the traditional focus on safety and soundness of individual institutions. We 

are overhauling our supervisory framework and procedures to improve coordination within our own supervisory staff and with other 
9 

supervisory agencies and to facilitate more integrated assessments 

of risks within each holding company and across groups of companies. 

Last spring the Federal Reserve led the successful Supervisory 

Capital Assessment Program, popularly known as the bank stress 

tests. An important lesson of that program was that combining onsite bank examinations with a suite of quantitative and analytical 

tools can greatly improve comparability of the results and better 

identify potential risks. In that spirit, the Federal Reserve is also 

in the process of developing an enhanced quantitative surveillance 

program for large bank holding companies. Supervisory information will be combined with firm-level, market-based indicators and 

aggregate economic data to provide a more complete picture of the 

risks facing these institutions and the broader financial system. 

Making use of the Federal Reserve’s unparalleled breadth of expertise, this program will apply a multidisciplinary approach that involves economists, specialists in particular financial markets, payments systems experts, and other professionals, as well as bank supervisors. 

The recent crisis has also underscored the extent to which direct 

involvement in the oversight of banks and bank holding companies 

contributes to the Federal Reserve’s effectiveness in carrying out 

its responsibilities as a central bank, including the making of monetary policy and the management of the discount window. But most 

important, as the crisis has once again demonstrated, the Federal 

Reserve’s ability to identify and address diverse and hard-to-predict 

threats to financial stability depends critically on the information, 

expertise, and powers that it has by virtue of being both a bank 

supervisor and a central bank. 

The Federal Reserve continues to demonstrate its commitment to 

strengthening consumer protections in the financial services arena. 

Since the time of the previous Monetary Policy Report in July, the 

Federal Reserve has proposed a comprehensive overhaul of the regulations governing consumer mortgage transactions, and we are 

collaborating with the Department of Housing and Urban Development to assess how we might further increase transparency in the 

mortgage process. We have issued rules implementing enhanced 

consumer protections for credit card accounts and private student 

loans as well as new rules to ensure that consumers have meaningful opportunities to avoid overdraft fees. In addition, the Federal 

Reserve has implemented an expanded consumer compliance supervision program for nonbank subsidiaries of bank holding companies 

and foreign banking organizations. 

More generally, the Federal Reserve is committed to doing all 

that can be done to ensure that our economy is never again devastated by a financial collapse. We look forward to working with 

the Congress to develop effective and comprehensive reform of the 

financial regulatory framework. 

Thank you. 

Senator JOHNSON. [Presiding.] Thank you, Mr. Chairman. 

Is there an agreement that 5 minutes should be enough on the 

clock? I do not want to be overly rigid, but so be it. 

Chairman Bernanke, the weather has been unusually harsh 

across the country in the past month. This has disrupted business 
10 

and Government activity and is likely to have an impact on employment. Do you think the effects will be strong enough to show 

up in the next month’s employment statistics? 

Mr. BERNANKE. Senator, first I would say that the harsh weather 

will not have permanent effects on the—— 

Senator BUNNING. Turn on your microphone. 

Mr. BERNANKE. Pardon me. Senator, I would like to say first that 

the harsh weather is unlikely to have any permanent effects on the 

economy, simply a temporary effect. But it does seem likely that 

there will be some impact on the employment statistics for January. It is very hard to know exactly how much, but the snowstorms 

were during the week in which the information is gathered about 

payrolls. It may also affect unemployment insurance claims and 

some other kinds of information. So we will have to be particularly 

careful about not overinterpreting the data that we receive for January. 

Senator JOHNSON. As Congress grapples with the need for job 

creation and the need to reduce our mounting deficits and national 

debt, can you talk about the impact unemployment and the budget 

imbalance could have on inflation? 

Mr. BERNANKE. Well, currently Senator, inflation looks to be subdued. We are not expecting inflation to rise significantly in the 

near or medium term. 

On the one hand, the unemployment and the low use, utilization, 

the low rate of utilization of labor has been a force keeping wage 

gains very lower, which, of course, from a worker’ perspective is a 

problem. From the perspective of employers, they are seeing both 

very slow wage growth and because of all the cuts and cost-cutting 

measures, they are also seeing very strong increases in productivity, which are quite remarkable. So the combination of slow 

wage growth and high productivity gains means that the unit labor 

costs, the costs of production are, if anything, falling for most 

firms. So that, together with very weak demand in many industries, means that firms have very little ability or incentive to raise 

prices, which would, of course, tend to moderate inflation. 

On the deficit, the impact on inflation in the near term I think 

is limited. Of course, it is important that Congress, the Administration, find solutions to our longer-term debt problems. Otherwise, it 

is conceivable—and I am not anticipating anything in the near 

term, but it is conceivable that it could lead to a loss of confidence 

in aspects of the U.S. economy. It could affect interest rates. It 

could affect the value of the dollar. And those things could directly 

or indirectly affect the state of the economy, the recovery, and, of 

course, the rate of inflation. 

Senator JOHNSON. As the Federal Reserve begins to wind down 

purchases of mortgage-backed securities, what steps, if any, are 

needed to ensure stability in the housing market during this transition? 

Mr. BERNANKE. Well, as you know, Senator, we are at this point 

planning to end our purchases at the end of this first quarter. A 

question is to what extent will mortgage rates be affected by the 

end of our purchases. Of course, even though we have stopped purchases, we still retain on our balance sheet $1.25 trillion of mortgage-backed securities, and we believe that the holding of all those 
11 

securities off the market in itself will tend to keep mortgage rates 

down. 

We do not know for sure how much mortgage rates will respond 

to our leaving the market. So far, there is little evidence of much 

change in mortgage rates, but obviously, we have to keep monitoring that. If there is a response which seems to threaten the 

broader economic recovery, we certainly would be prepared to review that decision. But, again, at the moment it does not seem to 

be that a large change in mortgage rates or any effect on housing 

is evident. 

Senator JOHNSON. Although the minutes of the January 26–27, 

2010 Federal Open Market Committee meeting indicate that core 

measures of inflation have been stable, they also indicate that 

headline inflation with swings in energy prices and core inflation 

may have been held down by unusually slow increases in the price 

index for shelter due to the housing crisis. Do you think that potentially higher future energy and housing costs pose an inflationary 

threat in the medium run? 

Mr. BERNANKE. Well, we believe that the underlying trend of inflation, given stable expectations, given a very weak economy, looks 

to be subdued. Of course, we monitor energy and commodity prices 

very closely and they can vary substantially depending, for example, on the strength of the global recovery. Recently, energy prices 

have been roughly stable and futures prices don’t indicate an expectation of sharp increases in the near term. So, again, we will 

continue to monitor energy prices, but currently, at least, they are 

not presenting a major inflationary threat. 

The very high vacancy rates in rental properties are keeping 

rents down, as well as vacancies in homes, as well, and our anticipation is that shelter costs are going to remain quite subdued for 

some time. 

Senator JOHNSON. Senator Shelby. 

Senator SHELBY. Thank you. 

Chairman Bernanke, this Committee continues, as you well 

know, to wrestle with financial reform and the role of the Fed has 

been a significant part of that debate, as you are well aware. 

Chairman Dodd has previously proposed stripping the Fed of its 

regulatory authority, allowing you and your colleagues to focus on 

your monetary policy, lender of last resort, and payment systems 

functions and so forth. On the other hand, some on the Committee 

have argued in favor of allowing the Fed to retain some type of regulatory authority over the largest institutions, perhaps some of the 

others. 

What do you see—how do you see such an approach, as a net 

positive or a net negative here, and what would you do as Chairman of the Board of Governors of the Fed if the will of the Congress was to give the Fed another opportunity to be a regulator? 

What would you change, considering all the problems that were 

had in the last 7 years in the regulatory process? 

Mr. BERNANKE. Thank you, Senator. As you know, I think that 

stripping the Federal Reserve of its supervisory authorities in the 

light of the recent crisis would be a grave mistake for several reasons. 
12 

First, we have learned from the crisis that large, complex financial firms that pose a threat to the stability of the financial system 

need strong consolidated supervision. That means they need to be 

seen and overseen as a complete company, reflecting the developments not only in their banks, but also in their securities dealers 

and all the various aspects of their operations. 

A bank supervisor which focuses on looking at credit files is not 

prepared to look at the wide range of activities of a complex international financial firm. The Federal Reserve, in contrast, by virtue 

of its efforts in monetary policy, has substantial knowledge of financial markets, payment systems, economics, and a wide range of 

areas other than just bank supervision, and in our stress test, we 

demonstrated that we can use that whole range of multidisciplinary skills to do a better job of consolidated oversight. 

By the same token, we need to look at systemic risks. Systemic 

risks themselves also involve risks that can span across companies 

and into various markets. There again, you need an institution 

that has a breadth of skills. It is hard for me to understand why 

in the face of a crisis that was so complex and covers so many markets and institutions you would want to take out of the regulatory 

system the one institution that has the full breadth and range of 

those skills to address those issues. 

Let me mention your second point, and I think your point is very 

well taken. As I discussed in my testimony, we have taken very, 

very seriously both changes in our performance, changes in the 

way we go about doing supervision, but also changes in the structure of supervision, and we have made very substantial changes in 

order to increase the quality of our supervision, to increase our 

ability to look for systemic risks, and to use a multidisciplinary 

cross-expertise platform to look at these different issues. So we are 

very committed, and I would be happy to discuss with you through 

a letter or individually more details. 

I guess I would also like, if I might just have one more second, 

the Federal Reserve, of course, made errors and made mistakes in 

the supervisory function, but we were hardly alone in that respect 

and there were—— 

Senator SHELBY. But what have you learned? I guess that is the 

question. 

Mr. BERNANKE. Well, my—— 

Senator SHELBY. You and the Board of Governors. What have 

you learned? 

Mr. BERNANKE. We have learned several things. We have 

learned, first, that regulations need to be tougher, and we have led 

the effort to strengthen capital requirements, to strengthen liquidity requirements, to put more controls, risk controls into these companies. We have learned that we need to have a more risk and systemic-oriented approach and we have changed our approach to do 

that. So we have gone at this very extensively. 

Senator SHELBY. Mr. Chairman, I want to briefly get into the 

Volcker Rule and size limits. The Administration recently proposed, 

as you well know, that limitations be imposed on banks and bank 

holding companies with respect to trading activities, including proprietary trading, the so-called Volcker Rule. The Administration 

also proposed placing limitations on what was referred to as, quote, 
13 

‘‘excessive growth’’ of the shares of liabilities at the largest financial firms. 

What are your views on the Volcker Rule proposal, and separately, on the proposal to limit excessive growth in the firms’ liabilities? And do the regulators right now have the power, as some 

people have suggested, to invoke the Volcker Rule, or would you 

need legislation if the Congress so thought it was necessary? 

Mr. BERNANKE. Senator, first, I think we would all agree that we 

don’t want companies taking excessive risks when they are protected by the government safety net, so that is very important. 

There are obviously multiple ways to address those risks and they 

include capital requirements, and we have increased capital requirements, as well as, for example, restrictions on executive compensation, which affect willingness to take risks. 

If you go about imposing the Volcker Rule, I think it would be 

difficult to do on a purely legislative basis because of the potential 

for having unintended consequences. So while on the one hand you 

may want to restrict purely proprietary trading, you also want to 

distinguish that from, say, appropriate hedging behavior—— 

Senator SHELBY. You have to be careful, don’t you? 

Mr. BERNANKE. You have to be careful of unintended consequences. Hedging, market making, customer activities can involve ownership of securities for a period of time. I do think if you 

want to go in that direction, you should at least allow some role 

for the supervisors to make determinations about individual activities. I think it would not be inappropriate if a supervisor determines that a company doesn’t have the managerial or risk capacity 

to appropriately manage a particular activity, for the supervisor to 

be able to restrict that activity. 

I would argue that we have that authority to some extent now, 

but if Congress wants to reinforce that, of course, it couldn’t hurt. 

Senator SHELBY. Thank you, Mr. Chairman. 

Senator JOHNSON. Senator Reed? 

Senator REED. Thank you very much, Mr. Chairman, and welcome, Chairman Bernanke. 

A follow-up on the Volcker Rule. How would you implement it if 

you were to do it through your regulatory process? 

Mr. BERNANKE. We would do it as part of our overall risk management assessment. We would look at the range of activities that 

the company engages in. There might be some activities that would 

be explicitly prohibited by legislation, say perhaps owning a hedge 

fund, for example. But if there are other activities, such as purchasing of, say, credit default swaps, I think it would be appropriate for the supervisor to, first of all, ascertain that the use of 

credit default swaps is primarily intended to hedge other positions 

and therefore is overall a net reduction in risk for the company as 

opposed to an increase or a speculative increase in risk. 

Second, even if the purposes of the program are in some sense 

legitimate, there is still the question of whether the company has 

adequate managerial risk management resources to properly manage those risks, and what we saw in the previous crisis, and I 

think this is one of the things we really learned, is that many 

large, complex companies didn’t really understand the full range of 

risks that they were facing and as a result they found themselves 
14 

exposed in ways they didn’t anticipate. So if a company didn’t have 

strong risk management controls and a strong culture of system— 

enterprise-wide risk management, I think that would be also 

grounds for the supervisor requesting either substantial strengthening in those controls or eliminating those activities. 

Senator REED. Just an observation. Those controls are much 

more rigorous today, but they tend to erode over time, particularly 

as these unpleasant crises fade. And also, the capacity of the regulators, the Federal Reserve and other regulators, to make very 

nuanced judgments about management, et cetera, there is really a 

question of regulatory capacity as well as managerial capacity that 

at least the last several months suggests that it won’t be handled 

by simply sort of letting you do what you inherently can do now. 

Mr. BERNANKE. Well, certainly Congress could provide guidance 

about what they would like to see shut down or make specific statutory recommendations or statutory laws. But another—I am sorry. 

I lost my train of thought. 

Oh, yes, sorry. I just recalled. I think another part of the reform 

package that is very important is the resolution authority and 

measures taken to address the too-big-to-fail problem. If you can 

address the too-big-to-fail problem and get market discipline affecting firms so that investors will have an incentive to try to evaluate 

the risk taking of those firms, that will be an additional—not a 

panacea, but it will be an additional factor helping the regulators 

and the firm itself make good decisions. 

Senator REED. Underlying this discussion of the Volcker Rule is 

a more general principle, I think. That is, what risks should taxpayers support? I think there is a consensus that traditional commercial banking, which everything has a risk, has historically been 

supported and should be supported. But the ability to access your 

credit facilities and your authority under 13(3) by large financial 

institutions whose primary activity is not commercial banking but 

either proprietary trading, which is inherently riskier, I mean, 

there is a real question here of whether they should have that access and I think that is at the heart of the Volcker Rule. 

To your point about too big to fail, I mean, the size has not been 

indicative of the sort of capacity to fail, so again, I just—there are 

real questions that we have to wrestle with with respect to, as a 

policy that you will implement, whether we are going to, with taxpayers’ money, support very profitable risk-taking activities when 

they work and catastrophic activities to taxpayers when they don’t 

work. 

Mr. BERNANKE. Well, Senator, as an example, consider the savings and loans, which basically were killed by interest rate risk. 

Today, they would either be able to securitize the loans that they 

made or they would be able to hedge that interest rate risk. 

So I am not disagreeing with you at all. I think we all agree that 

we don’t want excessive risk taking, particularly on a ‘‘tails, I win, 

heads, you lose’’ basis, certainly. But there are some legitimate 

purposes for using securities and we just want to make sure not 

to increase the risk—— 

Senator REED. No, I recognize the difficulty of sorting out a proprietary trade. You don’t have the staff, frankly, to do that, to keep 

up with every trading platform and every trading floor in the coun-
15 

try. So that is why I think there has to be perhaps a simpler approach, since these organizations are so large in terms of their 

trading versus the commercial banks, they might not qualify for 

the same type of support. 

Thank you. 

Senator JOHNSON. Senator Bunning? 

Senator BUNNING. Thank you, Mr. Chairman. Thank you for 

being here. 

On the discount rate increase, how much lending is currently 

outstanding at the discount window? I don’t want to know the people, I just want to know the amounts. 

Mr. BERNANKE. I believe it is in the order of $17 to $20 billion. 

Senator BUNNING. OK. If that is the case, since there is so little 

discount window borrowing going on, the increase in the discount 

rate seems to be more for show than for substance. On top of that, 

you and the Fed have gone out of your way to downplay the importance of that move. Why should anyone take that move as a sign 

that you are serious about taking away the punch bowl at this 

time? 

Mr. BERNANKE. Well, Senator, what we have been trying to do 

is to eliminate the extraordinary support that we have provided financial markets, and we had a wide range of programs that try to 

address the dysfunction in the commercial paper market, money 

market mutual funds, interbank markets, repo markets, and a variety of others. And as I mentioned in my testimony, on February 

1, we shut down most of those programs. By June, we will have 

no more of these 13(3) programs—— 

Senator BUNNING. Except—except what Senator Shelby brought 

up. On Tuesday, the Treasury announced that they were starting 

up a supplemental financing program again. It is $200 billion-plus. 

Under that program, Treasury issues debts and deposits the cash 

with the Fed. That is the effective same thing as the Fed issuing 

its own debt, which you know is not legal. 

Mr. BERNANKE. What it does—— 

Senator BUNNING. There are—well, let me finish with the question and you can answer. What are the legal grounds that the Fed 

and Treasury used to justify that program? And did anyone in the 

Fed or Treasury object when the program was created? 

Mr. BERNANKE. Well, legally, we are the fiscal agent of the 

Treasury and we hold Treasury balances that they—for all kinds 

of purposes, so there is no—— 

Senator BUNNING. But they are not allowed to issue debt, Treasury. 

Mr. BERNANKE. Treasury is allowed to issue debt. 

Senator BUNNING. On its own? 

Mr. BERNANKE. I don’t—they issue bills and other kinds of debt 

all the time. 

Senator BUNNING. Oh, yes, Treasury notes, Treasury bills, Treasury 2-years, 5-years, 10-years. But you are buying—you buying 

their debt. 

Mr. BERNANKE. We are just paying them interest on their deposits on our balance sheet. 

Senator BUNNING. OK. That isn’t the answer that I wanted. 
16 

Given what you learned during the AIG crisis and the bailout, 

do you think Congress should be doing something to address insurance regulation or the commercial paper markets? 

Mr. BERNANKE. Well, Senator, I think AIG is the poster child for, 

first, consolidated supervision. It did not have a strong consolidated 

supervisor that was paying attention to its derivatives activities, 

for example. That is very important to do. Second—— 

Senator BUNNING. Were those the ones in England? 

Mr. BERNANKE. No, those were the ones, the CDS—the credit default swaps that the Financial Products Division was exposed—— 

Senator BUNNING. Weren’t they located in London? 

Mr. BERNANKE. Well, they were in any case accessible to U.S. 

regulators. 

Senator BUNNING. I didn’t ask that question. I said, but didn’t 

AIG have an office in London that did those things? 

Mr. BERNANKE. It had some foreign offices, but I believe that the 

Financial Products Division is headquartered in Connecticut. 

Senator BUNNING. OK. Go right ahead. 

Mr. BERNANKE. So again, to address AIG issues, you need a 

strong consolidated supervisor that can identify those kinds of risks 

to the company and you also need some methodology, and I think 

you would agree that we don’t want to have too-big-to-fail firms. 

We don’t want the Fed involved in these bailouts. So you need an 

alternative legal structure. We have supported a resolution regime. 

I know this Committee is considering alternatives that would allow 

the government, excluding the Fed, to wind down a firm like this 

in a crisis in a way that would not bring down the overall financial 

system. I think that is a very important direction. 

Senator BUNNING. Does any other Fed Governor have their own 

staff? 

Mr. BERNANKE. The staff of the Federal Reserve works for all the 

Governors. There is no—— 

Senator BUNNING. That is not my question. 

Mr. BERNANKE. The staff—no, not dedicated, except for clerical—— 

Senator BUNNING. OK. Do you think they should? 

Mr. BERNANKE. No. I think we all work collectively and we all 

get the support from the entire staff. 

Senator BUNNING. Do Fed Governors have access to the Board’s 

staff recommendations or do they only get to see the recommendations you approve of? 

Mr. BERNANKE. They see the staff recommendations. 

Senator BUNNING. They do? 

Mr. BERNANKE. Yes. 

Senator BUNNING. Have you ever tried to change or influence 

staff recommendations before they were presented to the Board? 

Mr. BERNANKE. Not final recommendations, no. 

Senator BUNNING. Your e-mails tell us differently. 

Mr. BERNANKE. You are referring to an e-mail where a preliminary draft by a couple of economists—— 

Senator BUNNING. It was the Fed staff. That is what the—— 

Mr. BERNANKE. It was Fed staff, but it wasn’t the Fed staff’s recommendation because it was a draft done by several people in the 

division, not by the leadership of the staff. And it was, in any case, 
17 

a recommendation that was outdated because of changes in circumstances. 

Senator BUNNING. That was in your opinion. 

Mr. BERNANKE. Yes, sir. 

Senator BUNNING. I have more, but I am past my time. 

Senator JOHNSON. Senator Akaka? 

Senator AKAKA. Thank you very much, Mr. Chairman. 

I want to welcome Chairman Bernanke back to the Committee 

and also to congratulate and welcome him and wish him well in his 

continued tenure as Chairman of the Board of Governors of the 

Federal Reserve System. We both share a commitment to improving the lives of working families by better educating, protecting, 

and empowering consumers. 

Chairman Bernanke, Chairman Dodd and other Members of this 

Committee helped develop and enact meaningful card reform legislation. I am proud that the law includes provisions from my Credit 

Card Minimum Payment Warning Act which will provide consumers with detailed personalized information on their billing 

statements and access to reputable credit counseling services. Consumers will learn the true costs of making the minimum payments 

and how long it will take for them to pay off their balance if they 

only make minimum payments. Consumers are also provided with 

the amount that they need to pay to eliminate their outstanding 

balance within 36 months, which is the typical length of a debt 

management plan. This useful information recently started appearing on statements, and I looked at it and was happy to see it. 

My question to you is, how will the personalized credit card minimum payment information influence the behavior of consumers, 

and also what additional personalized disclosures pertaining to 

other financial service products would enable consumers to make 

better informed choices? 

Mr. BERNANKE. Well, Senator, I congratulate you on those contributions. As you know, the Federal Reserve developed extensive 

disclosures for credit cards as well as some rules which were very 

extensively incorporated in the Congressional bill that passed and 

was signed by the President. 

Obviously, as you point out, the more information you can provide consumers, the better decisions they can make and the kinds 

of information about minimum balances, time to pay off, the cost 

of the card, the penalties they might face, those are the kinds of 

things people need to shop. If they can shop, the market becomes 

more competitive and you get a market that better serves consumers. 

We have been very focused on good disclosures, good information. 

We have in our disclosure reform that we did earlier, we—I don’t 

see Senator Schumer here yet today, but there is the so-called 

Schumer Box, which has—— 

Senator BUNNING. He is at the White House. 

Mr. BERNANKE.——has a list of key features of the account. We 

have done a lot of work on that to make it easier to read and more 

understandable to consumers. 

One of the innovations pioneered by the Federal Reserve has 

been to use consumer testing. We have gone out and instead of 

having some lawyers just sort of figure out what should be in the 
18 

disclosure, we have actually gone out to shopping malls and had 

people look at the disclosures and then we have tested them to see 

how much they understand and retain. And by doing that, we 

think we are improving considerably the ability of folks to understand what they are buying and encouraging them to shop around 

to get a better deal. 

So again, I congratulate you on your contributions to this and on 

your longstanding support for financial literacy and for clear disclosures. 

Senator AKAKA. Mr. Chairman, unfortunately, investment banks, 

credit card issuers, and predatory lenders through their excessive 

bonuses and unfair treatment of consumers are giving the term 

‘‘bank’’ an even greater negative connotation. I am afraid that 

abused or angry consumers may continue to underutilize mainstream financial institutions. After having grown up in an 

unbanked home, I personally know the challenges that confront the 

unbanked. Many community banks and credit unions provide vital 

financial services to working families by providing opportunities for 

savings, borrowing, and low-cost remittances. 

The question is, why is it essential that we attempt to encourage 

the unbanked and the underbanked to utilize mainstream financial 

institutions more? 

Mr. BERNANKE. Well, Senator, as you well know, for various reasons, lack of information, cultural reasons, and so on, many minority or immigrant communities don’t make much use of the regular 

banking system. The cost of that is they may find themselves paying much more for check cashing or for short-term borrowing or for 

other services that they need. In most cases, they would be better 

off in a mainstream financial institution. 

We have encouraged banks, credit unions, and other financial institutions to reach out to minority neighborhoods by, for example, 

having people on staff who speak the language, through advertising 

and through other activities, through the CRA, the Reinvestment 

Act. By doing that, you attract people from these communities and 

give them access to the broader financial network. It helps them 

not only to get better deals on their financial services, to pay less 

for check cashing, for example, but it also helps them begin to 

learn how to save or learn how to borrow for a home and do other 

things that you need to have access to the broad mainstream financial system in order to achieve. 

So I think it is very important that mainstream financial institutions continue to reach out to people in their communities, including minorities and immigrants, to attract them to use of mainstream financial services. 

Senator AKAKA. Thank you. Thank you very much, Mr. Chairman. 

Senator JOHNSON. Senator Johanns? 

Senator JOHANNS. Thank you, Mr. Chairman. Mr. Chairman, 

good to see you again. 

Mr. Chairman, let me start out and say that I think we have 

done some good work as we have tried to move through regulatory 

reform. I think everybody, quite honestly, has learned from the 

mistakes of the last years, no doubt about that. But I must admit, 

I have a concern about something that I think is shared by prob-
19 

ably everybody here. It may be a little sensitive, but I want to ask 

about it, and that is Fannie and Freddie. 

We have spent a lot of time talking about too big to fail and looking at private companies and how gigantic they had gotten and 

how that really put us in a box. In the end, the taxpayers got put 

on the hook for that. Isn’t Fannie and Freddie the government 

version of that too big to fail? And how do you get out of that box? 

Mr. BERNANKE. Well, Senator, first, as I am sure you know, the 

Federal Reserve has a long record of warning about the dangers of 

the structure of Fannie and Freddie. There are numerous dangerous, including conflicts of private and public interest, and most 

notably, insufficient capital to support the very large portfolios that 

they held. And, in fact, it turned out they didn’t have enough capital and now the U.S. Government, the taxpayer, is subject to substantial cost. 

Right now, we are kind of in no man’s land. Fannie and Freddie 

are in conservatorship. They are part of the government’s efforts to 

maintain the housing market because there really is no other 

source of mortgages at this point, or mortgage securitization. But 

certainly, this is not a sustainable situation and I think it is very 

important that we move toward clarifying the longer-term status. 

There are numerous ways to go. I have talked about some in a 

speech. But to give two examples, one would be a privatization approach, which might allow the privatized firms that securitize 

mortgages to purchase insurance from the government for the 

mortgages that they package and sell. 

Another possibility would be just to acknowledge that these are 

government utilities and incorporate them with Ginnie and FHA 

and other government agencies. So those are two very different approaches, but both of them have the advantage of eliminating this 

platypus kind of, you know, neither fish nor fowl status that those 

firms have now. 

Senator JOHANNS. Neither approach will eliminate the exposure 

that the taxpayer faces. Would you agree with me there? 

Mr. BERNANKE. Well, for example, if you had a situation where 

privatized firms were not allowed to hold large portfolios, which is 

a major source of the risk, first; and, second, that they paid actuarially fair premiums to the Government as opposed to the implicit 

support they had before, there would still be risks to the taxpayer, 

but at least there would be some compensation, some premium is 

being collected. 

Senator JOHANNS. In effect, it sounds to me like a Government 

liquidation, and I do not know that I would want to personally buy 

into that. But I guess as a taxpayer we would all end up buying 

into that. But it is a huge number, isn’t it? It is probably $1 trillion 

plus of exposure. 

Mr. BERNANKE. Well, it depends how you count exposure. Of 

course, the mortgage-backed securities outstanding are in the trillions. 

Senator JOHANNS. Yes. 

Mr. BERNANKE. The Government’s commitment at this point is a 

couple hundred billion to those institutions. 

Senator JOHANNS. Let me also draw your attention to something, 

and I am running out of time here, but I was just catching up on 
20 

some things, and I noticed today that first-time unemployment filings have increased. That was not expected. Durable goods orders 

have fallen the most since August. That is not a good sign. And 

that excludes, I think, transportation. 

The market has responded by dropping at least at this point by 

160, and I appreciate the market can have up days and down days. 

I am starting to read more and more articles about the national 

debt interfering with economic recovery. And yet I do not see an 

effort to slow that down here. 

In fact, if we were just to stand down and say, OK, we will adopt 

the President’s plan, there are trillion dollar deficits over the next 

decade. I cannot imagine how that turns out for—you know, I will 

be 70 years old the next decade. I am not going to live long enough 

to pay that off. That means my children and grandchildren are 

going to have to deal with that. 

I am beginning to wonder, Mr. Chairman—and I do not want 

this to sound overly pessimistic, but I am beginning to wonder 

whether low interest rates really have any possibility of spurring 

this economy. And I will tell you what I am thinking about, and 

you may not even have enough time to respond. Unless there is demand, unless we can get consumers back into it, it just seems very 

unlikely to me that you are going to see much growth. 

I talked to people who handle the freight—the railroads, the 

trucking companies. They are not seeing much improvement. All 

these signs point to a situation where, quite honestly, this economy 

is still enormously flat. And I am not sure that offering somebody 

an interest rate at 2 percent versus 4 percent is going to get us on 

the other side of this, and I would just like your thought on that. 

Mr. BERNANKE. Well, first, I agree that the economy is still very 

weak and very disappointing in that respect. I think low interest 

rates do tend to help, and I will give you a couple of examples. 

One, you mentioned the durable goods. Notwithstanding—I have 

not had a chance to get into those numbers in detail this morning, 

but investment, actually equipment investment, equipment and 

software investment has been something of a bright spot and has 

been growing. And part of the reason for that is that larger firms 

at least have pretty good access to credit at reasonable rates in the 

corporate bond market, for example, and that has supported the investment rebound, which is a big part of what we are seeing in the 

recovery. 

Another example is that the Fed’s actions, interest rate actions 

and our purchases of mortgage-backed securities, have helped bring 

down mortgage rates. That has helped to some extent to stabilize 

demand for housing and helped—as you may know, house prices 

seem to have flattened out and begun to rise a bit, which is very 

important for consumers in terms of their wealth, in terms of the 

risk of foreclosure, and in terms of, you know, restarting activity 

in the residential construction sector. 

So those are two examples where we see growth. We did have 4- 

percent growth in the second half of 2009. I think the issue we face 

is will the growth be fast enough to materially reduce the unemployment rate at a pace that we would like to see, and that is a 

big uncertainty right now. But we are getting some output growth 

at this point. 
21 

Senator JOHANNS. Mr. Chairman, thank you. 

Senator JOHNSON. Senator Brown. 

Senator BROWN. Thank you, Mr. Chairman. Mr. Chairman, nice 

to see you. 

We all know for most of our Nation’s history—I am going to go 

in a bit different direction. For most of our Nation’s history, manufacturing and agriculture and transportation drove our economy, 

whether it is steel in Youngstown or agriculture around places like 

Lexington, Ohio, or the Port of Cleveland shipping raw materials 

and finished goods all over the Midwest. 

As an expert on—as an economic historian, as you are, and an 

expert on the Great Depression, you are aware, obviously, of the 

role of manufacturing, especially a historic role, in pulling our Nation out of recession. 

As many Ohioans can tell you, can painfully tell you, manufacturing steadily declined over the last three decades. At the same 

time, we know that the financial industry has rapidly expanded. 

As recently as the 1980s, manufacturing made up 25 percent of 

GDP; financial services made up less than half of that, in the vicinity of 11 or 12 percent. Those numbers crossed in the 1990s. Now 

it is almost a direct flip. Manufacturing, 12 percent; financial services, 20 or 21 percent. 

Wall Street’s output, put another way, was equal to all the Farm 

Belt States and the Industrial Belt States combined. In 2004, 44 

percent of all corporate profits in the United States came from the 

financial sector compared with 10 percent from manufacturing. 

And I say that as a preface to my question for this reason: Kevin 

Phillips, the writer, has noted sort of the history of great nations 

in the last 400 years. Habsburg Spain, the United Provinces of 

Netherlands, and Imperial England, all three saw their economies 

go from manufacturing, shipping, agriculture—depending on which 

of each of the three—and energy into more and more emphasis on 

financial services. And the financialization in that sense is what 

probably cost those empires their empire. They were countries that 

never really recovered in the wealth creation. It really is the fact 

that banking is not an independent source of wealth. It does not 

cause our prosperity. The success of banking is created by our success and our ability to create wealth. 

Then I hear people, when I talk about manufacturing policy, I 

hear your predecessors say this, I hear advisers in the White 

House, regardless of party, say we cannot have a manufacturing 

policy, we cannot pick winners and losers. Well, it is pretty clear 

in the 1980s that this country, this Government, your predecessors, 

and the Treasury Department picked winners and losers. They decided that financialization, the financial services sector should be 

the winner as we got rid of usury laws, as we changed rules and 

deregulated and all those things. So we put ourselves in a position 

where, as Kevin Phillips said, finance is the chosen sector of the 

U.S. economy. 

So my question is this: As your role, your statutory role, a mandated target of 4-percent unemployment, it is at least twice, maybe 

three times that right now. When I look at a building on the 

Oberlin College campus 20 miles from my house, fully powered by 

solar energy, the largest solar-powered building on any college 
22 

campus in America, about 8 years it was built. All the panels were 

built in Germany, a country that had an industrial policy that 

stimulated demand and supply and have built clean energy jobs 

way better than we have. You read the articles in the paper about 

what China is about to way outcompete us on alternative energy, 

solar and wind turbines. We know all that. We still sit with no 

manufacturing policy. 

So my question is this: As the economic historian that you are, 

are you troubled by the fact that the financial sector is now twice 

the size of the manufacturing sector? And I put parentheses around 

the next part of that, that no country that I can see in economic 

history has done well when that happened. Are you troubled by 

that? And if you are troubled by that fact that the financial industry is twice the size of manufacturing, flipping what it was, what 

should we do about it and what are you doing about it? 

Mr. BERNANKE. Well, financial services obviously has a place to 

play in a modern economy, and it is a productive industry in the 

sense that it helps allocate capital more effectively and share risk 

and do important things like that. I think we would all agree that 

over the past decade or so, financial services, residential construction, and some other sectors may have become too big relative to 

other sectors, and we are now seeing the painful unwinding of that 

process. 

I think the right way to address the size of financial services is 

to make sure that it is being productive and constructive, and that 

means having a good regulatory regime that directs—that provides 

a context in which financial services will do productive, constructive things for the economy. So good financial regulatory reform 

should lead the financial services industry to adjust to an appropriate size that is right for the economy. 

On manufacturing, it is really a mixed picture in the United 

States. We still are probably the biggest or one of the biggest manufacturers in the world. We are the most productive. We have had 

extraordinary increases in productivity, in manufacturing recently. 

That, in fact, is part of the reason why the employment share of 

manufacturing keeps going down, is that we need fewer workers to 

produce a car or an airplane than we used to. 

Senator BROWN. That is true, Mr. Chairman, but look at the 

profits of the financial services—the chasm between financial services and manufacturing is—the chasm is big in terms of the percentage of GDP. It is even larger in terms of profits in the last 5 

years. Keep that in mind. 

Mr. BERNANKE. So in terms of the financial industry, you know, 

I think markets should be allowed to work, but they should be allowed to work in an environment where regulation is appropriate 

and where there is an appropriate level playing field. So you would, 

I suppose, agree that financial services were not appropriately regulated or appropriately supervised. If we strengthen that regulation and allow appropriate changes to take place, that ought to 

bring down the size of the financial services industry to a size 

which is more appropriate for our economy. 

Manufacturing is another issue. I think there are lots of things 

that mostly Congress—I do not think the Federal Reserve has a lot 

of direct influence on any particular sector. But there are a lot of 
23 

things that Congress can do. There is tax policy, there is immigration policy, trade policy. 

There is the issue of picking winners and losers. I think that is 

difficult to do. But you gave the example of solar panels. Solar panels are a viable industry with Government support if the Congress 

determines that, for example, for global warming purposes that 

carbon-reducing technologies or capital is socially desirable and, 

therefore, supports that activity, then that will—the private sector 

will, therefore, come out and produce that. So that is a determination of Congress whether it needs a public subsidy. I do not think 

that many of those alternative energy sources would survive by 

themselves in a marketplace because whatever value they have in 

reducing carbon, for example, is not captured in their price in the 

market. 

So I guess what I am saying is that we need, first of all, better 

regulation in finance to bring finance down to an appropriate size 

and an appropriate set of functions. And there are a set of things 

that Congress can do to try to improve our trade balance, for example, to improve the tax policy. 

I think, frankly—and this is a topic that I never could get much 

traction on. I think that our immigration policy which restricts severely the number of highly trained, skilled immigrants is a problem because bringing those sorts of folks in helps our high-tech industries develop more competitive—become more competitive. So 

there are things I think you can do to strengthen manufacturing. 

I would also just note that while it has been a very severe recession in the manufacturing sector, manufacturing is, in fact, leading 

this recovery, as you pointed out. Industrial production has been 

very strong, and we are seeing, in fact, growth in manufacturing 

employment. So it has been important in that respect. 

Senator BROWN. One real quick closing statement. If manufacturing were even close to the same percentage of GDP as it was, 

think how much stronger—how much quicker we would come out 

of this recession in terms of recovery, just as a point of reference 

perhaps. 

Thank you, Mr. Chairman. 

Senator JOHNSON. Senator Vitter. 

Senator VITTER. Thank you, Mr. Chairman. Thank you, Mr. 

Chairman, for being here and for your work. Thank you for your 

monetary report. 

Mr. Chairman, when I go around my State and have town hall 

meetings and other things, obviously folks are real concerned about 

jobs and the recession. But I get just as many questions and expressions of concern about what they consider the next looming crisis caused by spending and debt. 

Now, obviously, you gave us a monetary report focused on things 

you can control. Federal spending and debt is not something you 

can directly control. 

What is your general projection and outlook, once we are out of 

this current recession, for the impact on the current levels of what 

are, in my view, unsustainable Federal spending and debt and the 

impact on the economy? 

Mr. BERNANKE. Well, Senator as you point out, at the moment 

we are in a deep recession. Revenues are down to 15 percent of 
24 

GDP. We have a lot of costs arising from the recession, and so deficits are extremely high. 

The really interesting question is: What is the structural medium-term deficit? If you look at the range of estimates provided 

by the OMB and the CBO over different scenarios and so on, most 

of them suggest that the deficit after we come out of recession, say 

2013 or so and the rest of that decade, should be somewhere between—will be somewhere between 4 and 7 percent of GDP. 

That is not a sustainable number. A rule of thumb is that in 

order to keep the ratio of outstanding Government debt to our GDP 

more or less constant—I mean, it would be better even to reduce 

it, but just to keep it constant, you need to have deficits more in 

the area of 2 1⁄2 to 3 percent. 

So I think it is important—so 4 to 7 percent is not sustainable. 

If it were actually to happen, what we would see is increasing interest costs, and eventually the markets would just entirely lose 

confidence in our fiscal policy, and interest rates would spike. 

So it is very important for Congress—even though we are now 

still in a very deep recession or in a very weak economy, it is important for Congress to try to clarify how we are going to exit from 

our fiscal position and try to provide a credible blueprint for how 

our Federal deficit will be controlled over the next 10 years and 20 

years. 

Senator VITTER. And just to follow up on that, let us say in the 

future we reach a point that we are truly out of this recession in 

a meaningful way and those deficits are where they are projected, 

4 to 7 percent, versus 2 1⁄2. How quickly would that become a major 

problem in terms of the economy? 

Mr. BERNANKE. Well, it could become a problem tomorrow if bond 

markets are not persuaded that Congress is serious about bringing 

down the deficit over time. But in any case, certainly if you look 

at the CBO numbers, you know, by 2025, 2030, under existing policies we are going to be seeing the curve very sharply rising 

and—— 

Senator VITTER. But surely way before that it would be an issue 

and a problem in terms of interest rates, et cetera. 

Mr. BERNANKE. Absolutely. Absolutely. And you would be seeing 

debt-to-GDP ratios rising; you would be seeing crowding out of investments and other problems. Yes, absolutely. 

Senator VITTER. So is it fair to say, you know, we are perhaps 

not seeing those immediate threats because we are in a serious recession? Once we come out of that, those immediate threats, the 

chances of their having a real negative impact elevate enormously. 

Mr. BERNANKE. That is right. And we are not completely sure we 

will not have negative effects even sooner than that. 

Senator VITTER. Before that. 

Mr. BERNANKE. Depending on how interest rates respond. 

Senator VITTER. Right. Mr. Chairman, I want to Fannie Mae and 

Freddie Mac. On June 18, the Treasury Secretary said before us, 

‘‘Fannie and Freddie were a core part of what went wrong in our 

system.’’ I assume you agree with that. 

Mr. BERNANKE. Yes, sir. 

Senator VITTER. We are discussing regulatory reform. In terms 

of the draft bills we are discussing, there is no title on Fannie and 
25 

Freddie. When should we be addressing that? Sooner rather than 

later, or when? 

Mr. BERNANKE. Well, I think for no other reason than just trying 

to reduce uncertainty in the markets, the sooner that you can come 

to some clarity on the future of Fannie and Freddie, the better. Of 

course, I understand that you are dealing with a lot of complex 

issues in financial reform and health care and in other areas right 

now. But it would be, obviously, helpful to try to get some clarity 

on that. 

That does not mean necessarily that you can get to that new situation quickly. It is going to take some time to move from the current situation to a more stable long-run situation. But certainly I 

hope Congress is looking at this issue now and thinking about 

where you want to go. 

Senator VITTER. OK. We are really not looking at the issue now, 

at least in a meaningful way. And the schedule, as I understand 

it, particularly from Treasury, is not until 2011. Is there any good 

reason, in your opinion, to essentially put that off to 2011? 

Mr. BERNANKE. Well, I think their concern is just that the agenda is so full and is there time, you know, for everyone to focus on 

that. And that is not my judgment to make, but I think that is 

their concern. I think they would agree that an earlier resolution 

would be better, certainly. 

Senator VITTER. OK. Mr. Chairman, I want to go to resolution 

authority and 13(3) type authority, and we have talked about this 

before, but it is really important so I want to have the discussion 

quickly again. 

If in our regulatory reform package we come up with a reasonable, workable wind-down mechanism to resolve large failed institutions in an orderly way, to take them down, to break them up 

in an orderly way, if we do that, would you support our also ending, taking away 13(3) and other similar authority from the Fed 

and others to put taxpayer dollars in large quantities into individual firms? 

Mr. BERNANKE. In short, yes, I would support that—13(3) has 

been used two ways. It has been used in what you would call bailouts, and it has been used in developing these broad-based lending 

facilities to help individual markets, like the ones we just closed 

down on February 1st. I think the latter is a valuable thing to have 

in case of a future crisis, but we would be happy to give up any 

involvement in the wind-down of failing, systemically critical firms. 

Senator VITTER. And just to make clear, I am talking about the 

former not the latter, so I think we are on the same page. 

Mr. BERNANKE. We are on the same page. 

Senator VITTER. As I understand the Treasury’s position, they 

say they support a resolution authority, but they essentially also 

want to keep that other authority as ‘‘foam on the runway,’’ as sort 

of a backup plan, however you want to term it. Do you think that 

is necessary or a good idea? 

Mr. BERNANKE. It depends on exactly how the resolution authority is structured. It might be that you want the Fed to be available 

to provide liquidity as part of the resolution process, for example. 

But, generally speaking, I prefer that you develop a process that 

leaves the Fed to do only its standard discount window lending 
26 

against collateral as it always has done, without use of the emergency authority. 

Senator VITTER. So if we get the resolution authority right, you 

do not see any need for that other authority with regard to individual firms continuing to exist? 

Mr. BERNANKE. We would be very happy if you could find a solution that allows us to give up that authority. 

Senator VITTER. OK. 

Senator JOHNSON. Could you gentlemen wrap it up? 

Senator VITTER. OK. I have one more question, which is about 

audits and transparency of the Fed. I welcomed your recent written 

comments about that as certainly movement in the right direction 

from my point of view. One thing you underscored was some delay 

in terms of disclosing certain action so as not to disrupt the markets in terms of an immediate disclosure of certain activity. 

What is your reaction to the idea of having the same disclosure 

with a lag for all loans and collateral used to secure loans made 

by the Fed—in other words, the normal discount window activity? 

Mr. BERNANKE. Including the names of the borrowers? 

Senator VITTER. Correct. 

Mr. BERNANKE. That is a concern that we have, and the problem 

is that if banks think they are going to be—that their names are 

going to be publicized, then they will not come even if they are 

under attack by the market, even if there is a panic or a run on 

the firm. So it is a very delicate issue. I think we will have further 

discussions, I am sure, but we are quite nervous about essentially 

shutting down the viability of this critical tool, which proved to be 

very valuable during the crisis. So that is something that we are 

concerned about, even, you know, with a delay. 

Senator VITTER. So even with a delay. 

Mr. BERNANKE. You know, I am sure we will have further discussions about this, but, you know, again, if a company is under attack by people who do not believe that it is stable and they know 

that if they go to the window, their name is going to be published 

even with some delay, they may feel that they have no option, that 

they will just have to fail, because if they go to the window and 

that is revealed, then the market will then believe that they, in 

fact, are not stable, and the whole purpose of the discount window 

loan will not be served. 

So that is a particularly sensitive one for us, even though that 

is a relatively small part of our lending. 

Senator VITTER. OK. Thank you. 

Senator JOHNSON. Senator Warner. 

Senator WARNER. Thank you, Mr. Chairman. I appreciate getting 

my time. 

Thank you, Chairman Bernanke, for being here. I do share one 

concern that Senator Vitter mentioned about the deficit, and, gosh, 

I wish we would have supported Senator Gregg’s proposal when we 

had a chance. I think it was still the best, perhaps last best proposal to actually force this Congress to take an up-or-down vote on 

a plan that would put us back into fiscal sanity. 

I want to come back on the question of financial regulation. Mr. 

Chairman, you make, I think, a strong case about the need to have 

sophisticated, strong supervision for bank holding companies and 
27 

that this supervision has to take a look at not just individual supervision but systemic risk in a macro level. I still think we are 

weighing where that role should be, and I am not sure, at least 

from my standpoint, while you make a strong case that you have 

fully made the case that it absolutely has to be deposited within 

the Federal Reserve, that it could perhaps be deposited elsewhere. 

You know, one of the comments you have made—and we are now 

18 months after the crisis, and you have said that you have looked 

at the Fed within supervision of the bank holding companies, 

stronger capital, stronger risk supervision. You know, we have had 

a lot of discussion over the last 18 months about size. We have 

talked a little bit earlier—Senator Reed raised questions about the 

Volcker Rule, and I share some of your concerns about how you 

draw those lines. Chairman Dodd raised the question about use of 

some of the instruments out there in terms of derivatives. 

Could you tell us a little bit in this last 18 months, with this increased focus on the large sophisticated bank holding companies 

that you currently supervise, you know, what steps that has taken 

to strengthen that supervision in a little more specific way than 

you did in your—— 

Mr. BERNANKE. Well, it would take me quite a long time. 

Senator WARNER. Perhaps you could give that for the record. I 

would like to see—— 

Mr. BERNANKE. OK. So just very briefly, there has been a lot on 

the regulatory side. We are working with our colleagues in Basel 

and elsewhere to substantially strengthen and modernize the capital requirements, liquidity requirements, executive compensation 

requirements, risk management requirements, and a whole raft of 

things just to give a tougher, stronger regime. So that is an important part. 

In terms of supervision, we are restructuring our internal organization, and we think a landmark event, a watershed event was the 

stress tests last spring, which were incredibly successful, which the 

Federal Reserve led. And I think the Federal Reserve’s input to 

that was to supplement the standard bank examiner going in looking at the credit file with a lot of analytical statistical information 

which helped improve comparability across banks, which helped to 

determine the factors underlying possible risks to banks, which integrated the macroscenarios so we could do stress tests and those 

sorts of things. 

So in our internal structure, we are, first of all, creating a new 

group which will bring together not just the bank supervisors but 

people from other dividends—and I mentioned the economists, the 

payment system people, the financial people, and so on—to manage 

the supervisory effort for the system as a whole, and they will be 

looking at a portfolio of firms, and so it will not be a firm-by-firm 

operation where this teams looks at Citigroup and this team looks 

at JP Morgan. Instead, they will be looking collectively at groups 

of firms doing horizontal comparisons and taking a more systemic 

type approach. 

On top of that, we will also have a quantitative evaluation team 

which increases something we have already done, which is currently for small banks, we do not go in every year or every 6 

months. What we tend to do is we look at a bunch of data, a bunch 
28 

of call report information, for example, and use statistical models 

to try and evaluate whether there are problems that we should go 

back and look. 

Well, expanding that idea in a much more sophisticated way, we 

can give these quantitative folks the license to look at a range of 

activities in the firms and look at them across firms and try to use 

their offsite type analysis to supplement and support the on-side 

analysis. 

Senator WARNER. Because I want to be absolutely sensitive to my 

colleagues’ times who have been waiting here for a long time, I 

want to just get one more point out. 

Mr. BERNANKE. Sure. 

Senator WARNER. I have got a lot of other questions, but I will 

take them at another time. 

Specifically in terms of, I believe, within safety and soundness 

you can look at proprietary trading, hedge fund activities, and private equity, whether you have ramped up on that, and one of the 

issues that one of the panels raised with us a little bit earlier that 

I thought was quite good was the whole question of interconnectedness, and I will close with that. But I would love to get your quick 

comments on that, recognizing other folks have been waiting a long 

time. 

Mr. BERNANKE. So we have not tried to apply the Volcker rules. 

We have not forbidden some activities. But we have—— 

Senator WARNER. Heightened. 

Mr. BERNANKE. Yes, we have heightened our activities, particularly with respect to risk management. We find that was the big 

Achilles heel in the whole situation, that firms did not really have 

a sufficient understanding of the broad-based exposure across all 

their business lines to certain kinds of risks. And we have been 

working very hard on that part. 

Senator WARNER. Interconnectedness. 

Mr. BERNANKE. On interconnectedness, this is a place, I think, 

where the Federal Reserve really has a comparative advantage. We 

have, for example, been working very hard on strengthening the 

operations of the credit default swap market, the tri-party repo 

market, et cetera. And in doing that, we are looking at how the— 

it is critical to us—you know, JP Morgan plays a critical role in the 

tri-party repo market. DTCC plays a critical role in the securities 

clearing markets and so on. 

So we are integrating those with our analysis of the firms, and 

that is extremely important. We are paying a lot of attention to 

that. 

Senator WARNER. Thank you, Mr. Chairman. 

Senator JOHNSON. Senator Gregg? 

Senator GREGG. Were you here earlier than I was, Jim? 

Senator JOHNSON. Senator DeMint? 

Senator GREGG. I think Senator DeMint was here. He left. I do 

believe he is—go ahead. 

Senator DeMint. Thank you, Mr. Chairman. 

Thank you, Mr. Bernanke, for enduring us again here. I really 

appreciate you being here. I apologize for missing some of the questions, but I did hear your testimony. 
29 

I would just like to get a broad perspective. I know we are talking about a lot of the details of financial monetary systems, but 

just maybe a larger concern. As I look at what we are doing here 

in Washington overall and a lot of the debate about specifics, it 

does seem that the underlying debate is more about are we going 

to have a free market economy or more of a centrally planned, government-directed economy. And there are very different views on 

monetary policy depending really on what our paradigm is, I believe. 

My concern is as I look at where we are even versus 5 years ago, 

that the Federal Government owns two of our largest auto companies, our largest insurance company, our largest mortgage company. We are heavy in debate about expanding government control 

of health care. We pretty much control the energy sector, where we 

drill, all of those kinds of things. We are considering now a new 

financial reform package that would supercede State control, go all 

the way down to payday lenders and pawn shops. And in the process of moving in this direction, we have created huge debts, 

unsustainable, and 10-year projections are more than a trillion dollars a year additional debt. 

My concern is that in your testimony, that you didn’t mention 

any of this. Not until we questioned the debt was it a concern. I 

mean, I know it is a concern. I am not suggesting it is not. But 

I would think that given the fact that the uniqueness of the American economic system has a lot to do with more of the Adam Smith 

invisible hand, bottom up, that the Chairman of our Federal Reserve would express some concern about the expansion of government ownership and controls of large sections of the private sector 

economy, knowing that there is a tipping point at some point where 

we no longer function as a free market economy. 

I am not sure if we have gone past that or not, but my concern 

and alarm is that you had not expressed any concern or alarm of 

the need for Congress to look at ways to devolve and divest of these 

things, to try to move things back in that direction. Is that not a 

concern, or is your focus just not—your focus is what you have to 

do with what you have got to work with and that is just not your 

area? 

Mr. BERNANKE. Well, Senator, first, I have, obviously, a lot of 

things to talk about, so I can’t cover everything of concern. 

Senator DeMint. Sure. 

Mr. BERNANKE. Let me talk about the financial sector, and I 

think there, that returning to a more market-oriented financial sector is a top priority and we are, in fact, doing that. For example, 

all the big banks have now paid back their TARP money and we 

are trying as quickly as we can to get those banks financed by private capital, which they have raised a great deal of private capital 

and it is very important. 

AIG, of course, is very problematic, but they are selling off assets 

in order to pay us back and they are making progress on that, and 

our objective there, of course, is to put them back in the private 

sector. 

We talked earlier about Fannie and Freddie, and I do think that 

we have to get away from this neither fish nor fowl situation where 

they are part public, part private. I think one solution would be to 
30 

privatize those firms, and I think that is an interesting direction 

to go. 

If I might, I think perhaps the most important thing, as a number of people have discussed, this Committee is looking at too big 

to fail, looking at resolution authorities and so on. If you were able 

to get a strong resolution authority, you would do more to bring 

back a level competitive playing field, market discipline into the financial sector than anything else that you can do, because with a 

true resolution authority where creditors know they will lose 

money, shareholders know they will lose money if the firm fails, 

then they have the incentive after that to evaluate the firm’s credit, quality, and their risk taking and so on, and that would, again, 

bring back competition, bring back market discipline. 

So I am very much in favor of bringing back the market in all 

these areas, recognizing that the financial sector does need appropriate regulation, but market forces and competition ought to play 

a substantial role, and I am all in favor of doing that and will work 

with you on that. 

Senator DeMint. Well, I appreciate that and I suspect we have 

very much the same philosophies about economies. But I think the 

country and the world needs to know that and I just would appreciate as you look at where we are that there is a need to back away 

from where we are. A lot has happened in a short period of time 

that has expanded the government scope in a lot of areas, and 

there is a big difference in central planning concepts, as you know 

more than I do, than free market accountabilities, and I think you 

are talking about and believe in. So I appreciate that and I thank 

the Chairman for allowing me to ask a question. I yield back. 

Senator JOHANNS. Senator Bayh? 

Senator BAYH. Thank you, Mr. Chairman. It is good to see you 

again. 

First, just a comment. I count myself as one who believes the Fed 

should retain a robust role in the supervisory area. The reason for 

that is that any new entity would have to get up to speed. There 

would be a learning curve there that I think would present some 

difficulties. 

Second, my strong impression is that you and your team have 

learned from the recent past about what can go wrong and that can 

inform your decisionmaking going forward. 

And third, my impression is that you gain some important insights by the oversight at the micro level informing your judgment 

about setting monetary policy and making macro decisions. So that 

is kind of my take on how we ought to view this going forward. 

Just a couple of questions. First, as you mentioned, the last quarter GDP figures were pretty good, but a big chunk of that was inventory rebuilding and that sort of thing. So we are all worried 

about the sustainability of the recovery, the risk of a double-dip, 

that sort of thing. 

You mentioned the key to this, to have it become self-sustaining, 

is final private demand. I don’t want you to wade into the political 

thickets, but there is a debate in Congress about what measures 

we might take to augment final private demand. Do you have any 

sense about what steps would be prudent to take at this time to 
31 

put some wind at the back of the recovery and ensure that it is 

sustainable? 

Mr. BERNANKE. Well, as you know, Senator, I don’t like to inject 

myself in debates on fiscal policies—— 

Senator BAYH. But as an economist, do you care to offer any? 

Mr. BERNANKE. Well, no. I don’t think I can separate my role 

that easily. My sense is, I mean, just as an observer, it seems that 

the Congress is debating a number of potential fiscal actions, but 

none of them are—I think no one is proposing anything of the scale 

we saw last year, as far as I know—— 

Senator BAYH. Well, let me put it another way. The Senate voted 

the other day on a $15 billion package. I voted for it. There are 

some good things in there. Some of my colleagues disagreed, took 

a different approach. Just in terms of scale, I mean, most people 

would say, even myself, some good things, I voted for it, but that 

is unlikely to be of a magnitude that is going to materially add to 

final private demand, to use your words. Do you have any sense 

about the scale that would be needed to have a material impact on 

final private demand? 

Mr. BERNANKE. Well, if these smaller programs are well designed, they can be very beneficial, and so we don’t want to denigrate those at all. But—— 

Senator BAYH. I didn’t mean to, and I wasn’t asking you to—— 

Mr. BERNANKE. But my sense is—— 

Senator BAYH. I am just trying to get a sense of, what can we 

do to try and ensure the economy gets the legs under it that it 

needs? 

Mr. BERNANKE. You know, this is going to sound like a dodge, 

but I think that if you are going to do more fiscal policy in the near 

term, it would be very constructive to combine that with more attention to the exit strategy 5 years down the line, because I think 

there is a risk that financial markets may begin to become concerned about the sustainability of U.S. Fiscal policy, and the more 

you can assure them of ultimate—— 

Senator BAYH. It is actually not a dodge. It leads to my second 

question. You were asked by Senator Dodd about the use of derivatives and the problems they are having in Greece. Senator Vitter 

touched upon the deficit. I would like to raise the question of 

Greece again. At what level—you know, our debt-to-GDP ratio is 

now going to be going up. Some of that is unavoidable because of 

the recession we are experiencing. But you are asking us to focus 

on the intermediate term, which I think is exactly right, and that 

is why I was a strong supporter of the Gregg-Conrad Commission 

and other steps. 

Do you have a sense, at what ratio of debt-to-GDP do we begin 

to approach the tipping point and really run into a risk of currency 

problems, interest rate spikes, the kinds of things that Greece is 

now experiencing? Do you have any judgment about that? 

Mr. BERNANKE. It is, of course, very hard to know, and we are 

very different from Greece in terms of the type of our economy, the 

size of our economy, the fact that we have our own currency and 

all those sorts of issues. 

Just to give you one number, Ken Rogoff and Carmen Reinhart’s 

book about financial crisis has been discussed in many quarters, 
32 

mentioned a 90 percent debt-to-GDP ratio as a level at which 

growth becomes impacted after that. Now, saying that, we have got 

a wide variety of experience among industrial countries, ranging up 

to very high levels in Japan and in other countries. But our historic 

levels, we were down to the 30s in terms of debt-to-GDP and I 

think heading toward a 100 percent debt-to-GDP ratio would be 

very undesirable, particularly given the aging of our society and 

those obligations we are facing longer term. 

Senator BAYH. And we are estimated to get up close to, what, 65, 

70 percent here over the next five to 10 years, something like that? 

Mr. BERNANKE. Yes. 

Senator BAYH. My last question. My time is about to expire. And 

we also finance our debt. Japan is mostly internal, isn’t it? We 

have a lot of external, which makes it a little bit different. 

Are you at all concerned about Japan’s recent steps to constrain 

demand there? What impact might—their economy is obviously 

growing very robustly. Does that present any risks to the global 

economy, the fact that they are moving in that direction? 

Mr. BERNANKE. Do you mean China? 

Senator BAYH. I am sorry. I misspoke. China. Yes, I did mean 

China. 

Mr. BERNANKE. No, I am not concerned about it. I think they 

have to make appropriate decisions about not overheating their 

economy. They are obviously growing very quickly. From our perspective, we would like to see more flexibility in their exchange 

rate as being part of the process for reducing overheating risks. 

But I think it is important that they achieve an appropriate balance between very rapid growth and the risks of overheating, the 

risks that their extensive credit extension becomes troubled. So, no, 

I am not particularly concerned about that right now. 

Senator BAYH. Thank you for your service, Mr. Chairman. Thank 

you. 

Senator JOHNSON. Senator Gregg. 

Senator GREGG. Thank you, Mr. Chairman. 

I want to associate myself with Senator Bayh’s comments relative to your regulatory authority and the range of regulatory authority that you should retain. I do think it is important that you 

be a major player in the regulatory atmosphere, and I do believe 

that although there are obviously errors that have occurred across 

the regulatory regimes, that yours are no more grievous than anybody else’s, and in fact, I think in many ways, less grievous. 

To get into this issue, however, which Senator Bayh has touched 

on, Senator Vitter has touched on, which is when is the tipping 

point, you have basically alluded to the fact that it may be sooner 

rather than later if the markets lose confidence in us, the international markets especially. And we have had a budget presented 

to us which puts us on a path, as you described, of unsustainability 

because deficits will run at five to 7 percent, debt will triple, and 

the public debt-to-GDP will hit 80 percent by 2015, 2016, and we 

will hit 60 percent this year, actually. 

So the question becomes, what do we need as a government to 

do to give the markets confidence that we are actually taking some 

action, real action in trying to control the out-year event, not the 

immediate issue of getting out of this recession, but the fact that 
33 

in the out years, we have an unsustainable situation which could 

lead to a significant financial issue for us as a nation and the reduction in our lifestyle and the quality of life and the standard of 

living of our children? 

Mr. BERNANKE. Well, the earlier question was about the debt-toGDP ratio, which was the tipping point. Another way to look at 

this is what does the trajectory look like? If the trajectory is such 

that you have an unstable dynamic where interest payments get 

larger and larger, that in turn increases the deficit, that in turn 

leads to higher interest payments and it explodes, essentially, then 

that is a situation where markets will become very concerned. 

So I think this is as much a political question as an economic 

question. The question is, can the Congress—and I recognize these 

are very, very hard problems. I don’t want to in any way downplay 

the difficulty that it is for Congress to address these hard problems. But it would be extraordinarily helpful if there was persuasive evidence that Congress had the political will to achieve over 

a number of years a stabilization of the debt-to-GDP ratio or of the 

fiscal trajectory, and that could be done either through whatever 

mechanisms you choose to undertake or it may be through specific 

plans, or maybe even through actions that you could take now that 

would affect expenditures and deficits in the out years. 

Senator GREGG. But something should be done. 

Mr. BERNANKE. It would be very—again, the point I would like 

to make is that there really is some—it is not just a question of 

paying today for a benefit tomorrow. There is benefit today if, in 

fact, you can increase the confidence of the markets that we will, 

in fact, address this issue. It gives you more scope and probably 

lower interest rates today. 

Senator GREGG. And arguably, the markets aren’t going to have 

that confidence unless there is an event which gives them confidence, which means the Congress has to address the gap between 

spending and revenues with the fact that that gap is primarily 

driven by spending, in my view. That is a rhetorical question. 

So where are we in the perception of the world relative to this 

country? Does the world have confidence that we can get our house 

back in order, in your opinion? 

Mr. BERNANKE. Well, the markets seem to have confidence. I 

mean, we can sell 20- and 30-year debt at relatively low interest 

rates and I think that is a vote of endorsement for the long-term 

ability of this country to respond to these challenges. But we have 

to make good that trust. We have to follow through. 

Senator GREGG. And if we look at the issue of how you get the 

money out of the market, you have put $2 trillion, basically, into 

the economy. Is that about right? 

Mr. BERNANKE. The Federal Reserve? 

Senator GREGG. Right. 

Mr. BERNANKE. Our balance sheet is $2.3 trillion. It was $900 

billion before we started, so we have expanded our balance sheet 

by about $1.4 trillion. 

Senator GREGG. So you have got to get that money back out at 

some point, right? 

Mr. BERNANKE. That is right. 
34 

Senator GREGG. And I notice you listed a few things here that 

you have got as mechanisms. There is one, however, that I wasn’t 

that familiar with. I am not familiar with it at all, to be honest 

with you. You said, the Federal Reserve is currently refining plans 

for a term deposit facility that can convert a portion of depository 

institution holdings of reserves balances into deposits that are less 

liquid. Does that mean you are basically going to require bigger reserves? 

Mr. BERNANKE. No. It means that instead of having reserves 

held at the Federal Reserve only on an overnight basis, we are 

going to offer a slightly higher interest rate so that banks will be 

willing to hold reserves with us for an extended period, and that 

would take those reserves out of the overnight money markets and 

give us more control over the Federal funds rate. 

Senator GREGG. So you are not raising the reserves. You are just 

going to say—— 

Mr. BERNANKE. No—— 

Senator GREGG.——you are going to encourage people to put 

more money in because you are going to pay them interest on it. 

That is part of your new authority? 

Mr. BERNANKE. That is part of the authority Congress gave us, 

to pay interest on reserves. 

Senator GREGG. OK. Thank you. 

Senator JOHANNS. Senator Bennet. 

Senator BENNET. Thank you, Mr. Chairman. 

I was going to go in a different direction, but just because the 

last part of this was so useful, I wanted to say we just heard the 

Fed Chairman talk about the political will in Congress to be able 

to address this issue, and I just—it is breathtaking to me as somebody new here that 2 weeks ago, we had the chance, because of 

Senator Gregg’s leadership and Senator Conrad’s leadership, to 

vote for a bipartisan commission—that is all it was—to take a look 

over a period of time and give us recommendations for an up or 

down vote, and we didn’t have the political will as an institution 

even to support that. 

So I want to thank Senator Gregg for his leadership and I hope 

we will try again, because we need to demonstrate the political will 

that you are talking about if we are not going to leave our kids a 

completely diminished set of opportunities. But I will come back to 

that. 

I wanted to ask you a question a little bit along the lines of what 

Senator Brown was asking, but different. In Colorado, if you look 

at the last period of economic growth in the country before we went 

into this terrible recession, that period of economic growth resulted 

in an $800 decrease in median family income in our State. So the 

economy grew, but middle-class family income fell, as it did across 

the country. For our middle-class families, I would argue, we have 

got two recessions that we are trying to recover from, this one and 

the last period of economic growth that didn’t drive their income. 

And at the same time, in our State, the cost of health insurance 

over that period went up by 97 percent. The cost of higher education went up by 50 percent. So you have got an economy that is 

driving costs of things that are important to move families ahead, 

but income is going down. And my understanding is it is the first 
35 

time our economy has grown in our history and median family income went down. 

I just wonder if you have some thoughts about that, because it 

just feels to me like there are some structural things going on in 

our economy that we need to be worried about, we need to concern 

ourselves with. 

Mr. BERNANKE. You are correct that median family income hasn’t 

kept up with average GDP or productivity, and there are a couple 

of arithmetic—— 

Senator BENNET. Let me just say, because you made that point 

earlier, as well, and at the same time, because of the increases in 

productivity you were talking about, it is not apparent where the 

jobs are going to come from to be able to help ameliorate the issues 

that I was just talking about. I will stop there. Sorry. 

Mr. BERNANKE. So just in terms of the median income, you mentioned one factor, which is the higher costs of benefits and medical 

care, those things which have lowered wage growth as opposed to 

total compensation growth. But more importantly is the increased 

inequality. So you can have a growing economy, but if there is 

more going to the top, then the median guy could still be coming 

down and that is an issue, and I have given some speeches on this 

and tried to address this to some extent. I mean, it is a very vexed 

issue. 

The one thing I think everybody agrees about is that income inequality is to some extent tied to educational skills and equality. 

We live in a society where technology is advancing, where we are 

competing with other countries that have very large pools of unskilled labor, and therefore, as Senator Brown was saying, union 

jobs in manufacturing are no longer a normal—or a predominate 

form of employment. So for all those reasons, in order to get more 

people to enjoy the benefits of productivity and higher economic 

growth, the training, skills, education is a critical part of that. 

One of the advantages of the United States in general is that we 

do have a very flexible system. You know a lot about education. 

But besides K to 12, we have community colleges, junior colleges, 

on-the-job training, and all kinds of other ways for people to get 

skills. 

One of the things I would just say to this Committee as you 

think about our unemployment problem, one of the lasting scars of 

this recession is very likely to be a generation of people who have 

been unemployed for a year or 2 years and will find it difficult to 

come back and get a decent job because their loss of skills, because 

they will have to explain why they were out of work for 2 years. 

So that retraining, those aspects are very important. 

Senator BENNET. I think I am already out of time, but let me just 

observe that I agree on the importance of education, and it is one 

of the sad facts of the legacy of the last decade that in addition to 

the economic issues we were just talking about, we started the decade, as I understand it, roughly first in college degrees, and 10 

years later, we are roughly 15th in the world. So I wouldn’t say 

that our track record there over the last 10 years has been particularly good, either, and it just is a reminder of the urgency that we 

face. 
36 

This is working itself out in the daily lives of Americans. I think 

there is enormous anxiety that we are at risk of being the first generation of Americans to leave less opportunity to our kids and our 

grandkids. It goes to the deficit and the debt issue we were talking 

about earlier and also these fundamental economic issues. 

I appreciate your being here today. Thank you. 

Mr. BERNANKE. Thank you. 

Senator JOHANNS. Senator Bennett. 

Senator BENNETT. Thank you very much, Mr. Chairman, and 

Chairman Bernanke, I appreciate your being here. 

Picking up on what Senator Gregg was talking about, simply an 

observation so that everybody understands exactly what we are 

talking about. When we say political will, cut spending, two-thirds 

of the Federal budget is in mandatory spending, and that is a combination of the entitlements, Social Security, Medicare, Medicaid, 

farm subsidies, interest on the national debt. I am an appropriator. 

None of those items come before the Appropriations Committee. All 

of them are on autopilot to be spent by virtue of commitments that 

have been made. 

I once had a very wealthy man say to me, ‘‘Explain to me why 

the Federal Government sends me a check every month for,’’ I have 

forgotten the number, $250 or whatever it is. He says, ‘‘I don’t need 

it.’’ And I said, but Sam, you are entitled to it, and by law, we are 

going to give it to you whether we have got it or not. 

And let us make it very clear that when we are talking about 

spending, we are talking about fiscal policy, these are terms we 

hide behind when we talk to our constituents and give speeches 

about Congress has got to get tough on spending. The real fact is 

that we have got to have the courage to attack the most popular 

programs in American history. We have got to level with our constituents and tell them we are talking about the programs you 

value the most and you insist are off limits. If the entitlements are 

off limits for any kind of discussion here on fiscal policy, we are 

going to hit 10 percent of GDP within 24 months unless we have 

the courage to deal with. It is 65 to 67 percent of the budget now. 

We are on autopilot to see 75 percent of the budget within 10 years 

and the other 25 percent includes defense. So if you take defense 

out of the remaining 25 percent, you have got about 10 percent of 

the budget that you have to get tough on in order to solve this 

problem. 

All right. I have finished my soapbox, but I think anybody who 

is paying attention to these hearings ought to hear that and understand that because that is the reality. 

Let me get to a question relating to the debt. We had our experiences, you and I and all the rest of us, a little over a year ago with 

respect to TARP. One of the things you said to us at the time, and 

we banked on as we voted for TARP, was that this was not a bailout. This was money that would come back to the Treasury, would 

come back to the Federal Reserve, wherever it came from. And, in 

fact, you were right. The money is coming back, has come back. A 

lot of the major players of TARP have paid it back. 

Now, the Treasury is recycling that money. Senator Gregg and 

I have been very firm about we were in the room when the conversation was made as to what would happen to that money when 
37 

it came back, and we thought, naively, that we wrote into the law 

the requirement that when it came back, it would be used to pay 

down the national debt. But we have been informed by the Treasury lawyers that that is not what we did. 

I would like your reaction. My opinion is, TARP solved its problems. TARP did, indeed, avoid a worldwide depression—a worldwide collapse. We maybe are in a worldwide depression, but TARP 

did, indeed, avoid a worldwide collapse in that very difficult weekend in September when you came here and said, ‘‘I have run out 

of tools,’’ a very chilling kind of comment. One of my colleagues 

said, ‘‘I feel like I am in a James Bond movie,’’ listening to the 

Chairman of the Federal Reserve say we have run out of tools. 

I think TARP worked. My position, and I would like your reaction, is that having worked, it is now time to end it so that the 

Treasury does not recycle it and that when the money does come 

back from those people who benefited from TARP, it goes to pay 

down the national debt. I would like your reaction to that. 

Mr. BERNANKE. Well, first let me just say on the first part of 

your comments that this is why I think it is so very difficult to address these deficit problems, because those are very popular programs. 

I agree with you that the TARP, unpopular as it is, achieved its 

basic objective of stabilizing the banking system. It did not do as 

much as we would have liked to create more credit. It is now coming back. The financial firms—I would put aside the autos and the 

mortgages. 

Senator BENNETT. Right. 

Mr. BERNANKE. Just talking about the financial firms, including 

AIG, putting them all together it looks like a pretty good chance 

we are going to break even on that, which would be a remarkable— 

in the long run, which would be a remarkable achievement. 

You have put me in a very difficult position. I do not know how 

to adjudicate the legal debate. I think basically Congress—— 

Senator BENNETT. Forget the law. Just give me your opinion of 

whether or not you think TARP should be terminated. 

Mr. BERNANKE. It boils down—well, I do not think—I think 

Treasury was right not to terminate it unconditionally at this point 

because there is still some risk out there that we may have further 

financial problems. I think it is small. But to have some flexibility 

in case some new crisis were to arise, I think at least for a short 

period, is not unreasonable. 

I am afraid I am going to have to defer to Congress on whether 

or not you think the other programs that are being proposed, like 

support for small business lending and those things, are within the 

spirit of the TARP or good programs in themselves. I do not know 

how to help you on that one. 

Senator BENNETT. All right. Well, this Member of Congress 

thinks they are not. 

Thank you, Mr. Chairman. 

Senator JOHNSON. Senator Merkley. 

Senator MERKLEY. Thank you very much, Mr. Chair. And thank 

you, Chair Bernanke, for your testimony. 

I first wanted to note that when Senator Vitter asked the question on whether there is a need to limit the Fed’s ability to use Sec-
38 

tion 13(3) Federal Reserve Act emergency lending power funds to 

support individual firms, I just wanted to note that in Chair Dodd’s 

draft that action—that is, emergency lending to individual firms— 

is prohibited. And so a point I was asked to put forward and clarify. 

I wanted to turn to the issue of recapitalizing our community 

banks. This is something I hear about back home all the time, the 

challenge of these banks to be able to put out new loans given their 

leverage limitations and their capital challenges. And I had supported an effort to recapitalize community banks, and the Administration has now put forward a very similar plan. I was just wondering if you could give us any insights on your perceptions on how 

the role of community banks in supporting lending to small business might be a factor in the recovery of our economy. 

Mr. BERNANKE. Well, I think it is very important, and I guess 

on the subject of regulation, I guess I would like to remind the 

Committee that the Federal Reserve, although we have been very 

focused on large institutions over the last couple years because of 

the crisis, we also supervise a large number of community banks, 

State member banks, and they provide us very important information about the economy. We can learn from them what is happening at the grass-roots level, what is happening to lending. And, 

you know, to get to your question, that kind of information is very 

valuable for us as we try to understand what is going on in the 

economy. 

As you point out, the community banks have in many cases, 

when they are able, when they are strong enough, have been able 

to step up and provide lending. They are very important lenders to 

small businesses, for example. And as you say—and this was the 

issue that Senator Bennett was raising—one of the proposals that 

the Treasury has made is to create a fund that would capitalize 

small banks that demonstrate that they can increase their lending 

to small businesses. 

So in the spirit of my previous conversation with Senator Bennett, I am not going to endorse or not endorse that approach. There 

are other approaches also for addressing small businesses. But I 

would say that if you go do that, one suggestion the Treasury 

makes, which is to separate it from the TARP, maybe to pass it— 

this would address Senator Bennett’s question—to pass it separately so that it is not stigmatized or otherwise associated with the 

restrictions with the TARP, which increase the chance that that 

would be a successful program. But we certainly do value the small 

banks for what they are able to do, and if we are going to get this 

economy going again and get employment growing again, then 

small banks, small businesses are going to be critical for that. 

Senator MERKLEY. Thank you very much, and I want to turn to 

another issue, which is that I was meeting with a group of Members of Parliament from Canada two nights ago, and when I asked 

them about the economic meltdown and the impact on Canada, 

they smiled and said: 

Well, you know, we kept the risk out of our banking system, and now there 

is a huge economic movement in which we are going down, Canadians are 

going down and buying up the foreclosed real estate in the United States. 
39 

And certainly in your role, there is the chance to look at and learn 

how different models interacted around the world. And would you 

just take a second to comment on the Canada structure, how they 

managed risk, whether there are any insights for us here in our 

efforts to provide regulatory reform? 

Mr. BERNANKE. I will start with one point, which is that Canada’s monetary policy was very similar to that of the United States, 

and they had very different outcomes. So those who blame this on 

monetary policy should address that issue. I think the differences 

between Canada and the United States had to do with their regulatory structure, and there were two primary advantages that they 

had. 

First, they simply had a much more conservative bank supervisory structure in terms of what they allowed banks to do, in 

terms of the amount of capital that banks had. You know, in the 

go-go days, they would be considered staid and unexciting. But, of 

course, that turned out to be the right way to go, and they are 

looked at as models around the world as we look at banks supervision. 

The other thing that they did, which we did not avoid, was they 

avoided the deterioration in underwriting standards in mortgages 

and the proliferation of very low downpayments and bad underwriting and other problems that came back to bite us in the crisis. 

So they took a very conservative approach, and it really paid off 

for them, although given that they are the biggest trading partner 

of the United States, they still have had a significant recession, of 

course. 

Senator MERKLEY. Well, if I can follow up on your point about 

the underwriting standards, some have argued that the reason that 

Canada proceeded to maintain solid underwriting standards was 

that they had an independent consumer financial protection agency 

and that that vision of defending consumers from tricks and traps 

in lending was never subverted, if you will, to other goals, be they 

safety and soundness, monetary policy, and so forth. Any insights 

on the role that institution plays in Canada? 

Mr. BERNANKE. I do not know the facts on that, but I would 

agree with you that it is very important to have strong consumer 

protection laws. 

Senator MERKLEY. I think I am over my time now, so I will stop 

there. But thank you very much. 

Senator REED. [Presiding.] Senator Shelby, a second round. 

Senator SHELBY. Thank you, Mr. Chairman. 

Chairman Bernanke, the Chinese have made a number of comments about their massive U.S. Treasury holdings. Last year, they 

publicly ‘‘worried’’ about whether their investments were safe. Recently, they have expressed the belief that they should respond to 

some of the Obama Administration decisions by selling billions of 

Treasury holdings. 

While China does not have a financial interest in rapidly—I do 

not believe they do—dumping its U.S. dollar assets, it may have 

other competing political interests. 

Do you believe that there is a risk to stability of the financial 

system associated with risk to the value of the dollar stemming or 
40 

coming from international relations between China and the United 

States? 

Second, do you believe that China’s large dollar reserve holdings 

pose a threat to the stability of the global financial system given 

the leverage those holdings provide to China to enable it to pursue 

a policy of pegging its currency at an artificially low value? 

I know that is a mouthful, but I think these are important questions. 

Mr. BERNANKE. Well, let me try to address that. First is just the 

factual question. I do not think there has been any significant 

change in China’s holding of dollar reserves. 

Senator SHELBY. OK. 

Mr. BERNANKE. They have continued to acquire reserves. They 

have done that when the dollar was falling. They did that when the 

dollar was rising. 

Senator SHELBY. Do you think that is a good thing, a bad thing, 

or are you indifferent about it? 

Mr. BERNANKE. I think it arises from a couple of problems. 

Senator SHELBY. OK. 

Mr. BERNANKE. One problem is their foreign exchange policy to 

keep the currency pegged, and in order to do that, they have no alternative but to buy treasuries. The other reason is the global imbalances, the fact that they run this very large—which is related, 

of course, to foreign exchange policy, which is that they run a very 

large current account surplus while we run a current account deficit. And it was one of the objectives discussed by the G–20 leaders 

in the recent financial summits that we should all work to try to 

get a more balanced trade and capital flow situation. So I think it 

would be a healthier situation if China saved less and we saved 

more and as a result they were not accumulating dollar assets so 

quickly and we had a more balanced financial picture. 

I do think that those large capital flows and the potential instability of those flows can be a risk to our financial system, and, you 

know, I think we need to try to get those imbalances rectified. 

Senator SHELBY. Picking up—and it has already been mentioned 

a couple of times by Senator Vitter and others—about the GSEs, 

at this point, as has been said here, there is no indication that any 

GSE reform will take place in the near term. In fact, just yesterday 

Secretary Geithner indicated and I think you alluded to this—that 

the Administration is unlikely to provide a plan for reforming these 

institutions prior to 2011 at the earliest. 

I know it is difficult and I know it is costly, but while implementing reform will take time, could you describe to the Committee 

here some of the risks that we face should we not start the process 

of reform as soon as possible? In other words, if we kick the can 

down the road, we could cause difficult problems, could we not? 

Mr. BERNANKE. Yes, sir. First of all, I think you and I have a 

lot in common on this particular issue. 

Senator SHELBY. We have worked together on it. 

Mr. BERNANKE. We have worked together on it. The Federal Reserve has had concerns for a long time, and you were a supporter 

of very good, strong regulatory oversight of Fannie and Freddie. 

And unfortunately, you know, we know how it turned out, that 

they did not have enough capital. 
41 

You know, I think the current situation is worrisome. It obviously is a costly situation. And it also generates a certain amount 

of uncertainty in markets as people try to anticipate, you know, 

what the U.S. housing financial situation is going to be in the future. Housing policy is a very big part of our financial policy in this 

country, and the lack of clarity about that is an issue. 

Now, again, let me just say I sympathize with Secretary 

Geithner in that there is an awful lot going on and financial reform 

is complex. But I do hope we will be thinking about where we want 

to take Fannie and Freddie soon so that we can at least provide 

some clarity to the markets and to the public about, you know, 

where we think this ought to be. 

Senator SHELBY. Thank you, Mr. Chairman. 

Senator REED. Senator Menendez. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Chairman Bernanke, welcome and congratulations on your confirmation. 

Mr. BERNANKE. Thank you. 

Senator MENENDEZ. I was pleased to support you. 

Let me ask you, over the next few years, there is going to be 

more than $1 trillion in short-term commercial real estate loans 

that will reach maturity, and the ongoing credit crunch will make 

it very difficult for owners of viable commercial real estate to secure long-term financing. 

In 2007, at this Committee hearing with others, I said we were 

going to have a tsunami of foreclosures in the housing market. I 

was told that was an exaggeration. I wish they had been right and 

I had been wrong. And I see this as the next looming crisis. 

You know, it seems to me that the Federal Government failed to 

act on the warning signs about the home foreclosure crisis, and I 

am very concerned that we are not acting on increasingly clear 

warning signs about this commercial mortgage market. 

So I am wondering, first, do you believe that this is a very serious issue facing us down the road and might this emerge as our 

next economic crisis? And regardless of how you might characterize 

it, which I will wait to hear what you have to say, what do you 

think we can do? 

For example, I have been told that this is one in which community banks will face a fair challenge across the spectrum. Is, for example, allowing those banks to amortize losses over 10 years an option so that we do not completely dry up lending and at the same 

time maybe have a lot of these institutions close as a result of it? 

I am looking to get ahead of the curve, but that curve is coming—that tidal wave is coming really soon, and so I would like to 

hear your views on it. 

Mr. BERNANKE. Senator, I share your concerns about this. This 

is yet another place where the Federal Reserve’s oversight of small 

and regional banks has been very informative for us. We have been 

able to follow the situation closely and to look at its implications 

for the broader economy and for the financial system. 

It seems likely that small and regional banks will be facing a lot 

of challenges from losses on commercial real estate, and the bank 

regulators are watching this very carefully because it is going to 

put a lot of pressure on some banks. Chairman Bair, I think the 
42 

other day, put out a list of problem banks, which has been obviously increased, and one of the key reasons for that is the commercial real estate issues that a lot of small banks are facing. It has 

the implication not only of putting pressure on the banks, but if a 

small bank has lost capital because of its losses in commercial real 

estate, then it does not have the funds to make loans to small businesses, for example, so it can permeate, it can affect the broader 

economy as well. 

Just a few comments. As I said, we are very alert to this. We are 

concerned about it. We and the other bank regulators have tried 

to address it. We have put out commercial real estate guidance to 

the banks which attempts to address the question you raised about 

how to deal with debts that are coming due. And that guidance, 

one of the main purposes is, first of all, to avoid unnecessary 

writedowns. So one of the guidances we give is that a commercial 

real state project that is able to make the payments but whose collateral value has declined should not necessarily be written down 

for that purpose, for example. 

Our guidance also gives specific examples and helps banks see 

how they can restructure loans, just like we restructure residential 

mortgages, in ways that will keep the loan current without having 

a major writedown for the bank. So we have been doing that; as 

bank regulators, we have been trying to find solution. 

I also want to mention the TALF again, which is still open for 

commercial mortgage-backed securities. We have had a bit of success in bringing down commercial mortgage-backed security 

spreads and in starting up some activity, including activity outside 

of the Fed in creating new CMBS securities. So we are very focused 

on those issues, and we have addressed it in a number of different 

ways. 

I want to end with just a little bit of—I would not say good news, 

but lately the evidence on commercial real estate is that there 

seems to be some improvement in some places, that the fundamentals are a little better than we had feared in some cases as the 

economy has done a bit better. And as we said, we have seen some 

more progress in the CMBS market and in banks’ ability to restructure loans. 

I do not disagree with your initial characterization that this is 

a very, very serious problem that we have to continue to monitor, 

but I would put forward just a sliver of optimism recently in terms 

of some improvement in the outlook for that category. 

Senator MENENDEZ. If I may briefly follow up, Mr. Chairman? 

Chairman, I appreciate your answer, and I appreciate the guidance 

that the regulators have given. That is somewhat helpful. I am just 

concerned—and I am happy to hear that there is a sliver of a silver 

lining here about some improvement in certain sectors. 

But my sense is that that is not going to meet the challenge before us, and I hope that we are thinking prospectively about what 

else we need to do or be ready to do, because it seems to me that 

if the worst-case scenario happens—and I have to be honest with 

you. I have heard from a wide sector of community banks, and I 

have heard from a wide sector of those who are in the commercial 

real estate market, who tell me that there is not a market out 

there for the renewal of these mortgages. And as such, it could be 
43 

a body blow to this economy at a time that we are seeing recovery 

take place. And that would be hugely unfortunate as well as consequential in a very real way to our overall economy. 

So I would love to continue to engage with you on figuring out 

how we are going to continue from all different levels—not just the 

Federal Reserve, but we have also talked to the Treasury about 

this. We need to figure out how do we best meet this challenge, because it is a challenge that is coming. And while, you know, those 

who maybe were irresponsible beyond a certain degree will have to 

face the possibility of closure, the breadth and scope of this is 

something that I am afraid of the consequences of what it means 

to our overall economy. 

Mr. BERNANKE. Thank you. We are very focused on it and we 

would like to work with you on it. 

Senator MENENDEZ. All right. Thank you, Mr. Chairman. 

Senator REED. Senator Bennett? 

Senator BENNETT. Thank you, Mr. Chairman. 

The one thing that I hear most often and I think my colleagues 

hear most often as they talk about where we are right now, a constant, constant complaint that banks aren’t lending. And when I 

talk to the banks, they say, well, we are better than we were. Year 

over year, we are better in 2010 than we were in 2009, so the volume has gone up and we are doing our best, but we can’t find creditworthy borrowers. We are ready to loan, but we can’t find creditworthy borrowers. 

And then when I drill down a little more, I find the real challenge comes from regulators who come in with a definition of creditworthy borrowers that say to the bank, OK, you used to make 

auto loans at this number on your credit report and now, if that 

isn’t this higher number, you can’t make the auto loans. I have had 

business people with whom I have been involved personally, now 

divested myself, say we go to our bank with whom we have had 

a 30-year relationship, say we want to make this acquisition, and 

can we get a loan to fund it, and instead of saying yes, as the bank 

has always said before, we like your business plan, we like your 

track record, you are solid people, you know exactly what you are 

doing, they say, we will give you this loan if you can demonstrate 

that you can pay out of your current cash stream. Well, if I could 

pay out of my current cash stream, I wouldn’t be coming for the 

loan to try to make the acquisition. And so additional jobs or additional productivity that would come from what we would normally 

think of as very ordinary kind of transactions is simply not there. 

And inevitably, it always comes back to the regulators won’t let 

us do this. The regulators have tightened their requirements of 

what is considered creditworthy. 

You are the primary regulator. You see this, I am sure, every 

day, or at least your staff does. I would like your reaction to that 

because that is what I hear after the rhetoric is all over and the 

screaming is all over in a political way. That is what I hear from 

the business people. The banks are not supporting true entrepreneurial activity in this country, and until they do, we won’t get the 

jobs back, we won’t get the economic recovery going, and they are 

saying it is primarily because of tightened standards on the part 

of the regulators. 
44 

Mr. BERNANKE. Well, it is a difficult problem and one we are 

very focused on, as well. First of all, there is a tradeoff. Probably 

credit terms were too easy before the crisis. They have tightened 

up some. Lately, banks seem to have leveled out. They are not 

tightening any further, at least. But there is a tradeoff between 

making sure that you are really making good loans versus making 

sure that creditworthy borrowers are not denied. 

Now, our focus at the Federal Reserve has been to achieve an appropriate balance. We want to make sure that creditworthy borrowers who are creditworthy can obtain credit, and we have been 

very aggressive in trying to do that. We started with, again, these 

guidances, but these are instructions to our examiners as well as 

to the banks which say, first of all, that we strongly encourage 

banks to make creditworthy loans because it is good for the bank, 

it is good for the borrower, it is good for the economy. We have 

trained our examiners to take that approach. 

We have most recently put out yet another guidance on small 

business which actually says, you know, you should not be denying 

credit based on what business you are in, whether you are restaurant or whatever, or what geographic location you are in. Again, 

this issue about your collateral value. If that has declined, that 

should not be a reason not to make the loan. We are encouraging 

so-called Second Look Committees who look, again, at loans that 

have been turned down just to make sure that there is not a way 

to make that loan. 

So our guidances, our regulatory philosophy, our training of our 

examiners has been very focused on getting that appropriate balance. 

Now, I have said this in previous testimonies. People say, well, 

I am not convinced. What is your evidence? So since then, we have 

been really trying to do outreach and try to get information directly 

back from banks, small businesses. We have, for example, put 

questions in the NFIB’s Survey of Small Businesses to get more information about their credit experience. We are requiring banks to 

provide us more information on small business loans. We have a 

series of meetings and programs at the Reserve Banks which bring 

together small banks, small businesses, community development 

organizations, and so on. 

We are doing our best to go out there and find out what is really 

happening, because in some cases, I mean, I think you would 

agree, in some cases, the regulator is a good scapegoat and—— 

Senator BENNETT. Yes. I understand that. 

Mr. BERNANKE.——and gets the credit for the problem. But the 

Federal Reserve, because we have interest, of course, in safety and 

soundness, but we also have interest in a healthy economy, and 

that insight that we get and that balance is very important. I realize it doesn’t filter down to every bank and every situation, but we 

are making enormous efforts to get that balance. 

When you do talk to your business acquaintances, first, ask them 

who the regulator is who is causing the problem, because it is not 

always the Federal Reserve—— 

Senator BENNETT. I think that is fair. 
45 

Mr. BERNANKE. But if you are hearing stories related to the Federal Reserve, I would be more than happy to talk to you about it 

and hear more details. 

Senator BENNETT. Well, if I could just quickly, Mr. Chairman, 

one other aspect of this that I have discovered as I have talked to 

the people in the venture capital community, they say, we are not 

in the venture capital business anymore. To the degree we are investing any money, we are doubling down on previous bets, because 

the pattern used to be the venture capital would come in, fund the 

startup. Once the startup proved its viability, it would then go to 

a bank and get the money that it needed to get to the point where 

it could then make an IPO and go public. 

And, they said, we are now discovering that the start-ups that 

we funded in that first wave can’t get the bank funding, so to keep 

the organization alive and protect our first investment, we doubledown on our bet and we are now in a position we have never, ever 

been in before. We are providing what the banks used to provide, 

and as a consequence, there is no VC money available for new 

start-ups and new activities. 

So I am delighted to hear your focus on this. I think you are exactly right with the kinds of things you need to do and I simply 

encourage you to keep doing it. 

Mr. BERNANKE. We are hearing the same things on venture capital that you are hearing. 

Senator BENNETT. Thank you, Mr. Chairman. 

Senator REED. Thank you, Senator Bennett. 

Mr. Chairman, again, thank you for your testimony and for your 

leadership. You, in response to several questions, pointed out how 

central the housing sector is to our economy, and one of the areas 

of great concern to all of us is the mortgage foreclosure situation. 

Frankly, we have not effectively responded to that yet. It is a growing phenomenon. In my State, one out of ten homes are either in 

foreclosure or 90-days delinquent, and that saps not only the energy from the economy, but with the uncertainty in the employment market, with the fear of losing your home, particularly for 

people at mid-life, their sense of the American dream is 

evaporating. Part of what we have to do is not only get the economy right, we have to get the confidence of the American people 

restored, and their trust. 

So specifically, I am wondering what you can do as the Federal 

Reserve to compel institutions to do more to modify mortgages. I 

get complaints constantly, I am sure my colleagues do, that there 

is a help line number. You call it and, oh, yes, sure, and then we 

don’t get back to it. I know there are a lot of press releases about 

everything that is being done, but until I think you make it clear 

that this is an important objective, we will get a lot of motion and 

not a lot of results. 

And I would assume, for example, I would hope that as within 

your powers of supervising the management could insist that at 

least there is a calculation done for each mortgage, whether a refinancing would be better than a foreclosure, or something like that 

which would be an open process, a quick process, and encourage institutions that you regulate—if you can’t order them, then encourage them, and you have many tools to encourage them—to do more. 
46 

Mr. BERNANKE. We are doing so. I guess I would first mention 

that our mortgage-backed security purchases—— 

Senator REED. Yes. 

Mr. BERNANKE.——lowered the mortgage rate and allowed for 

some millions of refinances, which I am sure has been helpful. As 

you know, the leadership in terms of actual programs is the Treasury’s program, the HAMP program, and there are a few others, the 

Help for Homeowners and those, and we felt that our best way of 

contributing is to be supportive of those things and to strongly encourage both banks and, in our case, as consolidated supervisors, 

we also have supervisory responsibilities for non-bank subsidiaries, 

whether it is some servicers or mortgage companies or whatever, 

to participate and to be effective in those programs. 

And we have for some time now been both looking for solutions 

to barriers, legal or accounting barriers, and we have been doing 

research to try to support these programs. For example, we have 

long felt that the problem of being underwater, the principal issue, 

is a serious one, and so that was why we were supportive of some 

of these efforts, like the Hope for Homeowners, that involves a 

principal reduction. Unfortunately, that program apparently has 

not been successful in bringing in a lot of participation, but we continue to look at different approaches to get restructuring. 

I think it is encouraging. The Treasury, I know, is not only trying to do their best to ramp up the HAMP program, and I think 

we will see more permanent modifications coming in since they 

have a pretty big pipeline at this point, but they are also doing 

some pilot programs that involve alternative approaches. 

For example, one problem that their approach doesn’t deal with 

is the problem of somebody who is unemployed, can’t even make a 

reduced payment. So what is needed there is not a permanent 

modification but some temporary assistance. Another issue has to 

do with principal reduction. So in some of their pilot programs, I 

think they are looking to try to take some of these different approaches. 

We have worked with them, our economists worked with their 

economists, and we have been very engaged in trying to figure out 

what is the best approach. It is a very hard problem. Unfortunately, many foreclosures are just hard to avoid for a wide variety 

of reasons. But where there is a preventable foreclosure, it is not 

only in the interest of the borrower, but in the interest of the bank 

and of the whole economy to try to avoid it. 

Senator REED. I will concede, it is a difficult problem, but sometimes you have got to send a very strong message. For example, 

you know, could you set a goal, maybe institution by institution of 

modifications as a condition to access your credit facilities? These 

institutions are borrowing money at virtually zero percent and then 

they are turning around saying, we can’t modify a loan because of 

the interest, or we will do, from 8 percent, we will cut it 50 basis 

points, when essentially many of these people, when they pay their 

taxes, they are giving them zero percent loans. 

Mr. BERNANKE. Well, I don’t think we have to use that threat. 

I think we could use our supervisory authority, and we went 

back—in November of 2008, we made very clear in our guidance 
47 

that we expected full compliance and full cooperation on this issue 

and we have had many conversations with the banks and—— 

Senator REED. Expecting it and getting it are two different 

things, and I think we have reached the point we have got to get 

it, Mr. Chairman. I know you agree conceptually, but we have just 

got to move on this issue. Senator Menendez sort of previewed another potential problem with commercial, but we are in the midst 

of this great residential and it goes right to the core of economic 

confidence and ultimately consumer demand and everything else 

that we have to do. 

Let me switch quickly, and you have been very kind to take 

these questions, but at this juncture and going forward, are you 

using multiple tests for the adequate capital of institutions and the 

adequate sort of resources, i.e., leverage, indexes, liquidity measures, tangible capital as well as risk-based capital, or are you still 

essentially and formally simply relying upon the Basel capital requirements? 

Mr. BERNANKE. No, we have gone beyond that. We have a general principle that there are regulatory minima and then above 

that, you know, we reserve the right to push banks to do more, depending on the risks they take and so on. So to give two examples, 

one, we have actually worked with international colleagues to develop new liquidity principles. That was one of the, I think, real big 

shortcomings that was made evident in the crisis, that they didn’t 

have enough liquidity, and we have pushed banks to expand their 

liquidity and we have been pretty successful in doing that. 

The other example I would give is that another thing that was 

illustrated by the crisis was that a lot of the capital, quote-unquote, 

was not really very high quality. It wasn’t of much use when the 

crisis came. And so, for example, as we have worked with banks 

in the stress tests or as we work with banks who want to repay 

TARP, we have put very heavy emphasis on raising new common 

equity as the highest quality form of capital. 

So yes, and every bank is required to do an internal capital assessment that we work with them on to make sure that not only 

are they meeting all the regulatory minima, but they are prepared 

for serious stresses that might come down the road. 

Senator REED. Can I presume that you would not object to statutory language requiring multiple tests that are readily made and 

disclosed? 

Mr. BERNANKE. Well, I would like to talk to you about exactly 

what those tests would be. We already have capital and leverage 

requirements—— 

Senator REED. No, I would presume they would be the measures 

which you would agree and your colleagues would agree were appropriate, but they would not be simply one standard. Again, I 

think some of the problems with the Basel II, particularly, were 

the ability to rely exclusively on credit ratings for securitized products, many of which the banks were sort of structuring and then 

buying because they couldn’t sell them, but they were AAA-rated, 

so that was a very low charge on their risk-based capital but inherently very, very risky, as we found out, so—— 
48 

Mr. BERNANKE. We have been working on the charges and they 

have been substantially increased. We are currently testing out the 

implications of that. 

On the particular issue of these off-balance sheet vehicles, as you 

know, the new accounting standards will force banks to consolidate 

most of those onto their own balance sheet and so they will have 

to have a full capital charge against them. 

Senator REED. And one final question, Mr. Chairman, and that 

is we have talked a lot about derivatives. We all do recognize there 

is a long-term value to derivatives. My recollection is the Chicago 

Board in 1848 started trading agricultural futures. In fact, I think 

I recall a story where General Grant and General Sherman showed 

up to congratulate one of the architects for helping them win the 

Civil War because of being able to guarantee supply. So that is the 

question of the utility in that sense, and other senses, is not at 

stake here. 

But there also is the growing perception, and I am coming to a 

conviction, that many times these devices are used to avoid regulatory constraints. In the case of Greece, it might have been strictly 

legal, but clearly the intent was to avoid the budget limitations and 

the budget restrictions of joining the European Community. 

With respect to many other derivatives, for example, even commercial derivatives, because they are not typically recorded as 

lending, or in some cases not even on the books, it is borrowing 

that is not in violation of covenance with other lenders. It is borrowing that allows additional leverage. And one of the problems we 

are trying to recognize now is over-leverage. 

So to the extent that we have to deal with these derivatives, any 

thoughts our guidance about how we prevent them from being used 

not for economic hedging but for clearly and very deliberately— 

maybe legally, maybe not—avoiding your capital requirements, the 

lending covenants of a bank, and many other examples. 

Mr. BERNANKE. Yes. There are two related issues here. One has 

to do with circumventing accounting rules, which maybe is what 

Greece is about. After Enron, that turned out to be—a lot of financial arrangements essentially were structured to avoid accounting 

requirements and we, at that time, the Federal Reserve—not me 

personally, but the Federal Reserve—came down pretty hard, providing sets of rules and guidances to banks to assure that they 

were not creating special structures or in order to—— 

Senator REED. And yet they did. 

Mr. BERNANKE.——in order to avoid accounting rules. The Greek 

thing is from before that period, as far as we know. 

Senator REED. Yes. 

Mr. BERNANKE. We are looking into that, but as far as we know, 

that was about 10 years ago that those were done. So that is one 

set of issues. 

The other set of issues has to do with whether hedging, which 

is in principle a good thing, is actually true hedging or not, and the 

poster child for that would be the capital hedges that banks took 

out with AIG which allowed them to reduce their capital standards 

because they were, quote, protected by the credit default swaps 

with AIG. And there, the challenge is to make sure that when the 
49 

hedge takes place, that it is a true hedge and that it doesn’t induce 

other risks, like counterparty risks, for example, or liquidity risks. 

So it is a difficult technical problem, but you are absolutely right 

that derivatives have a legitimate role for hedging risks, but if they 

are used to distort accounting results or regulatory ratios, then 

that needs to be addressed. We are working on that as part of the 

broad reforms that Basel is undertaking. 

Senator REED. Thank you very much, Mr. Chairman. 

Mr. BERNANKE. Thank you. 

Senator REED. Seeing no other members, the hearing is adjourned. 

Mr. BERNANKE. Thank you. 

[Whereupon, at 11:49 a.m., the hearing was adjourned.] 

[Prepared statements and responses to written questions supplied for the record follow:] 
50 

PREPARED STATEMENT OF BEN S. BERNANKE 

CHAIRMAN, BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

FEBRUARY 25, 2010 

Chairman Dodd, Ranking Member Shelby, and other members of the Committee, 

I am pleased to present the Federal Reserve’s semiannual Monetary Policy Report 

to the Congress. I will begin today with some comments on the outlook for the economy and for monetary policy, then touch briefly on several other important issues. 

The Economic Outlook 

Although the recession officially began more than 2 years ago, U.S. economic activity contracted particularly sharply following the intensification of the global financial crisis in the fall of 2008. Concerted efforts by the Federal Reserve, the 

Treasury Department, and other U.S. authorities to stabilize the financial system, 

together with highly stimulative monetary and fiscal policies, helped arrest the decline and are supporting a nascent economic recovery. Indeed, the U.S. economy expanded at about a 4 percent annual rate during the second half of last year. A significant portion of that growth, however, can be attributed to the progress firms 

made in working down unwanted inventories of unsold goods, which left them more 

willing to increase production. As the impetus provided by the inventory cycle is 

temporary, and as the fiscal support for economic growth likely will diminish later 

this year, a sustained recovery will depend on continued growth in private-sector 

final demand for goods and services. 

Private final demand does seem to be growing at a moderate pace, buoyed in part 

by a general improvement in financial conditions. In particular, consumer spending 

has recently picked up, reflecting gains in real disposable income and household 

wealth and tentative signs of stabilization in the labor market. Business investment 

in equipment and software has risen significantly. And international trade—supported by a recovery in the economies of many of our trading partners—is rebounding from its deep contraction of a year ago. However, starts of single-family homes, 

which rose noticeably this past spring, have recently been roughly flat, and commercial construction is declining sharply, reflecting poor fundamentals and continued 

difficulty in obtaining financing. 

The job market has been hit especially hard by the recession, as employers reacted to sharp sales declines and concerns about credit availability by deeply cutting 

their workforces in late 2008 and in 2009. Some recent indicators suggest the deterioration in the labor market is abating: Job losses have slowed considerably, and 

the number of full-time jobs in manufacturing rose modestly in January. Initial 

claims for unemployment insurance have continued to trend lower, and the temporary services industry, often considered a bellwether for the employment outlook, 

has been expanding steadily since October. Notwithstanding these positive signs, 

the job market remains quite weak, with the unemployment rate near 10 percent 

and job openings scarce. Of particular concern, because of its long-term implications 

for workers’ skills and wages, is the increasing incidence of long-term unemployment; indeed, more than 40 percent of the unemployed have been out of work 6 

months or more, nearly double the share of a year ago. 

Increases in energy prices resulted in a pickup in consumer price inflation in the 

second half of last year, but oil prices have flattened out over recent months, and 

most indicators suggest that inflation likely will be subdued for some time. Slack 

in labor and product markets has reduced wage and price pressures in most markets, and sharp increases in productivity have further reduced producers’ unit labor 

costs. The cost of shelter, which receives a heavy weight in consumer price indexes, 

is rising very slowly, reflecting high vacancy rates. In addition, according to most 

measures, longer-term inflation expectations have remained relatively stable. 

The improvement in financial markets that began last spring continues. Conditions in short-term funding markets have returned to near pre-crisis levels. Many 

(mostly larger) firms have been able to issue corporate bonds or new equity and do 

not seem to be hampered by a lack of credit. In contrast, bank lending continues 

to contract, reflecting both tightened lending standards and weak demand for credit 

amid uncertain economic prospects. 

In conjunction with the January meeting of the Federal Open Market Committee 

(FOMC), Board members and Reserve Bank presidents prepared projections for economic growth, unemployment, and inflation for the years 2010 through 2012 and 

over the longer run. The contours of these forecasts are broadly similar to those I 

reported to the Congress last July. FOMC participants continue to anticipate a moderate pace of economic recovery, with economic growth of roughly 3 to 3 1⁄2 percent 

in 2010 and 3 1⁄2 to 4 1⁄2 percent in 2011. Consistent with moderate economic growth, 

participants expect the unemployment rate to decline only slowly, to a range of 
51 

1Primary dealers are broker-dealers that act as counterparties to the Federal Reserve Bank 

of New York in its conduct of open market operations. 2For further details on these tools and the Federal Reserve’s exit strategy, see Ben S. 

Bernanke (2010), ‘‘Federal Reserve’s Exit Strategy,’’ statement before the Committee on Financial Services, U.S. House of Representatives, February 10, www.federalreserve.gov/newsevents/ 

testimony/bernanke20100210a.htm. 

roughly 6 1⁄2 to 7 1⁄2 percent by the end of 2012, still well above their estimate of 

the long-run sustainable rate of about 5 percent. Inflation is expected to remain subdued, with consumer prices rising at rates between 1 and 2 percent in 2010 through 

2012. In the longer term, inflation is expected to be between 1 3⁄4 and 2 percent, the 

range that most FOMC participants judge to be consistent with the Federal Reserve’s dual mandate of price stability and maximum employment. 

Monetary Policy 

Over the past year, the Federal Reserve has employed a wide array of tools to 

promote economic recovery and preserve price stability. The target for the Federal 

funds rate has been maintained at a historically low range of 0 to 1⁄4 percent since 

December 2008. The FOMC continues to anticipate that economic conditions—including low rates of resource utilization, subdued inflation trends, and stable inflation expectations—are likely to warrant exceptionally low levels of the Federal 

funds rate for an extended period. 

To provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve is in the process of purchasing $1.25 trillion of agency mortgage-backed securities and about $175 billion 

of agency debt. We have been gradually slowing the pace of these purchases in order 

to promote a smooth transition in markets and anticipate that these transactions 

will be completed by the end of March. The FOMC will continue to evaluate its purchases of securities in light of the evolving economic outlook and conditions in financial markets. 

In response to the substantial improvements in the functioning of most financial 

markets, the Federal Reserve is winding down the special liquidity facilities it created during the crisis. On February 1, a number of these facilities, including credit 

facilities for primary dealers, lending programs intended to help stabilize money 

market mutual funds and the commercial paper market, and temporary liquidity 

swap lines with foreign central banks, were allowed to expire.1 The only remaining 

lending program for multiple borrowers created under the Federal Reserve’s emergency authorities, the Term Asset-Backed Securities Loan Facility, is scheduled to 

close on March 31 for loans backed by all types of collateral except newly issued 

commercial mortgage-backed securities (CMBS) and on June 30 for loans backed by 

newly issued CMBS. 

In addition to closing its special facilities, the Federal Reserve is normalizing its 

lending to commercial banks through the discount window. The final auction of discount-window funds to depositories through the Term Auction Facility, which was 

created in the early stages of the crisis to improve the liquidity of the banking system, will occur on March 8. Last week we announced that the maximum term of 

discount window loans, which was increased to as much as 90 days during the crisis, would be returned to overnight for most banks, as it was before the crisis erupted in August 2007. To discourage banks from relying on the discount window rather 

than private funding markets for short-term credit, last week we also increased the 

discount rate by 25 basis points, raising the spread between the discount rate and 

the top of the target range for the Federal funds rate to 50 basis points. These 

changes, like the closure of most of the special lending facilities earlier this month, 

are in response to the improved functioning of financial markets, which has reduced 

the need for extraordinary assistance from the Federal Reserve. These adjustments 

are not expected to lead to tighter financial conditions for households and businesses and should not be interpreted as signaling any change in the outlook for 

monetary policy, which remains about the same as it was at the time of the January 

meeting of the FOMC. 

Although the Federal funds rate is likely to remain exceptionally low for an extended period, as the expansion matures, the Federal Reserve will at some point 

need to begin to tighten monetary conditions to prevent the development of inflationary pressures. Notwithstanding the substantial increase in the size of its balance sheet associated with its purchases of Treasury and agency securities, we are 

confident that we have the tools we need to firm the stance of monetary policy at 

the appropriate time.2

Most importantly, in October 2008 the Congress gave statutory authority to the 

Federal Reserve to pay interest on banks’ holdings of reserve balances at Federal 
52 

3The Federal Reserve has recently developed the ability to engage in reverse repurchase 

agreements in the triparty market for repurchase agreements, with primary dealers as counterparties and using Treasury and agency debt securities as collateral, and it is developing the capacity to carry out these transactions with a wider set of counterparties (such as money market 

mutual funds and the mortgage-related government-sponsored enterprises) and using agency 

mortgage-backed securities as collateral. 4 In December the Federal Reserve published a proposal describing a term deposit facility in 

the Federal Register (see Board of Governors of the Federal Reserve System (2009), ‘‘Federal 

Reserve Board Proposes Amendments to Regulation D That Would Enable the Establishment 

of a Term Deposit Facility,’’ press release, December 28, www.federalreserve.gov/newsevents/ 

press/monetary/20091228a.htm) We are now in the process of analyzing the public comments 

that have been received. A revised proposal will be reviewed by the Federal Reserve Board, and 

test transactions could commence during the second quarter. 5See Bernanke, ‘‘Federal Reserve’s Exit Strategy,’’ in note 2. 

6Last month the Federal Reserve said that it would welcome a full review by the GAO of 

all aspects of the Federal Reserve’s involvement in the extension of credit to the American International Group, Inc. (see Ben S. Bernanke (2010), letter to Gene L. Dodaro, January 19, 

www.federalreserve.gov/monetarypolicy/files/letterlaigl20100119.pdf). The Federal Reserve 

would support legislation authorizing a review by the GAO of the Federal Reserve’s operations 

of its facilities created under emergency authorities: the Asset-Backed Commercial Paper Money 

Market Mutual Fund Liquidity Facility, the Commercial Paper Funding Facility, the Money 

Market Investor Funding Facility, the Primary Dealer Credit Facility, the Term Asset-Backed 

Securities Loan Facility, and the Term Securities Lending Facility. 

Reserve Banks. By increasing the interest rate on reserves, the Federal Reserve will 

be able to put significant upward pressure on all short-term interest rates. Actual 

and prospective increases in short-term interest rates will be reflected in turn in 

longer-term interest rates and in financial conditions more generally. 

The Federal Reserve has also been developing a number of additional tools to reduce the large quantity of reserves held by the banking system, which will improve 

the Federal Reserve’s control of financial conditions by leading to a tighter relationship between the interest rate paid on reserves and other short-term interest rates. 

Notably, our operational capacity for conducting reverse repurchase agreements, a 

tool that the Federal Reserve has historically used to absorb reserves from the 

banking system, is being expanded so that such transactions can be used to absorb 

large quantities of reserves.3 The Federal Reserve is also currently refining plans 

for a term deposit facility that could convert a portion of depository institutions’ 

holdings of reserve balances into deposits that are less liquid and could not be used 

to meet reserve requirements.4 In addition, the FOMC has the option of redeeming 

or selling securities as a means of reducing outstanding bank reserves and applying 

monetary restraint. Of course, the sequencing of steps and the combination of tools 

that the Federal Reserve uses as it exits from its currently very accommodative policy stance will depend on economic and financial developments. I provided more discussion of these options and possible sequencing in a recent testimony.5

Federal Reserve Transparency 

The Federal Reserve is committed to ensuring that the Congress and the public 

have all the information needed to understand our decisions and to be assured of 

the integrity of our operations. Indeed, on matters related to the conduct of monetary policy, the Federal Reserve is already one of the most transparent central 

banks in the world, providing detailed records and explanations of its decisions. 

Over the past year, the Federal Reserve also took a number of steps to enhance the 

transparency of its special credit and liquidity facilities, including the provision of 

regular, extensive reports to the Congress and the public; and we have worked 

closely with the Government Accountability Office (GAO), the Office of the Special 

Inspector General for the Troubled Asset Relief Program, the Congress, and privatesector auditors on a range of matters relating to these facilities. 

While the emergency credit and liquidity facilities were important tools for implementing monetary policy during the crisis, we understand that the unusual nature 

of those facilities creates a special obligation to assure the Congress and the public 

of the integrity of their operation. Accordingly, we would welcome a review by the 

GAO of the Federal Reserve’s management of all facilities created under emergency 

authorities.6 In particular, we would support legislation authorizing the GAO to 

audit the operational integrity, collateral policies, use of third-party contractors, accounting, financial reporting, and internal controls of these special credit and liquidity facilities. The Federal Reserve will, of course, cooperate fully and actively in all 

reviews. We are also prepared to support legislation that would require the release 

of the identities of the firms that participated in each special facility after an appropriate delay. It is important that the release occur after a lag that is sufficiently 

long that investors will not view an institution’s use of one of the facilities as a possible indication of ongoing financial problems, thereby undermining market con-
53 

7For further information, see Board of Governors of the Federal Reserve System (2009), ‘‘Federal Reserve Issues Proposed Guidance on Incentive Compensation,’’ press release, October 22, 

www.federalreserve.gov/newsevents/press/bcreg/20091022a.htm. 

fidence in the institution or discouraging use of any future facility that might become necessary to protect the U.S. economy. An appropriate delay would also allow 

firms adequate time to inform investors through annual reports and other public 

documents of their use of Federal Reserve facilities. 

Looking ahead, we will continue to work with the Congress in identifying approaches for enhancing the Federal Reserve’s transparency that are consistent with 

our statutory objectives of fostering maximum employment and price stability. In 

particular, it is vital that the conduct of monetary policy continue to be insulated 

from short-term political pressures so that the FOMC can make policy decisions in 

the longer-term economic interests of the American people. Moreover, the confidentiality of discount window lending to individual depository institutions must be 

maintained so that the Federal Reserve continues to have effective ways to provide 

liquidity to depository institutions under circumstances where other sources of funding are not available. The Federal Reserve’s ability to inject liquidity into the financial system is critical for preserving financial stability and for supporting depositories’ key role in meeting the ongoing credit needs of firms and households. 

Regulatory Reform 

Strengthening our financial regulatory system is essential for the long-term economic stability of the nation. Among the lessons of the crisis are the crucial importance of macroprudential regulation—that is, regulation and supervision aimed at 

addressing risks to the financial system as a whole—and the need for effective consolidated supervision of every financial institution that is so large or interconnected 

that its failure could threaten the functioning of the entire financial system. 

The Federal Reserve strongly supports the Congress’s ongoing efforts to achieve 

comprehensive financial reform. In the meantime, to strengthen the Federal Reserve’s oversight of banking organizations, we have been conducting an intensive 

self-examination of our regulatory and supervisory responsibilities and have been 

actively implementing improvements. For example, the Federal Reserve has been 

playing a key role in international efforts to toughen capital and liquidity requirements for financial institutions, particularly systemically critical firms, and we have 

been taking the lead in ensuring that compensation structures at banking organizations provide appropriate incentives without encouraging excessive risk-taking.7

The Federal Reserve is also making fundamental changes in its supervision of 

large, complex bank holding companies, both to improve the effectiveness of consolidated supervision and to incorporate a macroprudential perspective that goes beyond the traditional focus on safety and soundness of individual institutions. We are 

overhauling our supervisory framework and procedures to improve coordination 

within our own supervisory staff and with other supervisory agencies and to facilitate more-integrated assessments of risks within each holding company and across 

groups of companies. 

Last spring the Federal Reserve led the successful Supervisory Capital Assessment Program, popularly known as the bank stress tests. An important lesson of 

that program was that combining onsite bank examinations with a suite of quantitative and analytical tools can greatly improve comparability of the results and 

better identify potential risks. In that spirit, the Federal Reserve is also in the process of developing an enhanced quantitative surveillance program for large bank 

holding companies. Supervisory information will be combined with firm-level, market-based indicators and aggregate economic data to provide a more complete picture of the risks facing these institutions and the broader financial system. Making 

use of the Federal Reserve’s unparalleled breadth of expertise, this program will 

apply a multidisciplinary approach that involves economists, specialists in particular financial markets, payments systems experts, and other professionals, as 

well as bank supervisors. 

The recent crisis has also underscored the extent to which direct involvement in 

the oversight of banks and bank holding companies contributes to the Federal Reserve’s effectiveness in carrying out its responsibilities as a central bank, including 

the making of monetary policy and the management of the discount window. Most 

important, as the crisis has once again demonstrated, the Federal Reserve’s ability 

to identify and address diverse and hard-to-predict threats to financial stability depends critically on the information, expertise, and powers that it has by virtue of 

being both a bank supervisor and a central bank. 

The Federal Reserve continues to demonstrate its commitment to strengthening 

consumer protections in the financial services arena. Since the time of the previous 
54 

8For further information, see Board of Governors of the Federal Reserve System (2009), ‘‘Federal Reserve Proposes Significant Changes to Regulation Z (Truth in Lending) Intended to Improve the Disclosures Consumers Receive in Connection with Closed-End Mortgages and HomeEquity Lines of Credit,’’ press release, July 23, www.federalreserve.gov/newsevents/press/bcreg/ 

20090723a.htm. 9For more information, see Board of Governors of the Federal Reserve System (2009), ‘‘Federal Reserve Approves Final Amendments to Regulation Z That Revise Disclosure Requirements 

for Private Education Loans,’’ press release, July 30, www.federalreserve.gov/newsevents/press/ 

bcreg/20090730a.htm; Board of Governors of the Federal Reserve System (2009), ‘‘Federal Reserve Announces Final Rules Prohibiting Institutions from Charging Fees for Overdrafts on 

ATM and One-Time Debit Card Transactions,’’ press release, November 12, 

www.federalreserve.gov/newsevents/press/bcreg/20091112a.htm; and Board of Governors of the 

Federal Reserve System (2010), ‘‘Federal Reserve Approves Final Rules to Protect Credit Card 

Users from a Number of Costly Practices,’’ press release, January 12, www.federalreserve.gov/ 

newsevents/press/bcreg/20100112a.htm. 10For further information, see Board of Governors of the Federal Reserve System (2009), 

‘‘Federal Reserve to Implement Consumer Compliance Supervision Program of Nonbank Subsidiaries of Bank Holding Companies and Foreign Banking Organizations,’’ press release, September 15, www.federalreserve.gov/newsevents/press/bcreg/20090915a.htm. 

Monetary Policy Report in July, the Federal Reserve has proposed a comprehensive 

overhaul of the regulations governing consumer mortgage transactions, and we are 

collaborating with the Department of Housing and Urban Development to assess 

how we might further increase transparency in the mortgage process.8 We have 

issued rules implementing enhanced consumer protections for credit card accounts 

and private student loans as well as new rules to ensure that consumers have 

meaningful opportunities to avoid overdraft fees.9 In addition, the Federal Reserve 

has implemented an expanded consumer compliance supervision program for 

nonbank subsidiaries of bank holding companies and foreign banking organizations.10

More generally, the Federal Reserve is committed to doing all that can be done 

to ensure that our economy is never again devastated by a financial collapse. We 

look forward to working with the Congress to develop effective and comprehensive 

reform of the financial regulatory framework. 
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RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM BEN S. BERNANKE 

Emergency Lending Under Section 13(3) 

Q.1.a. Charles Plosser, President of the Federal Reserve Bank of 

Philadelphia, stated in a recent speech his belief that the Fed’s 

emergency 13(3) lending authority should be either eliminated or 

severely curtailed (‘‘The Federal Reserve System: Balancing Independence and Accountability,’’ presented February 17, 2010 by 

President Plosser to the World Affairs Council of Philadelphia). He 

stated: 

I believe that the Fed’s 13(3) lending authority should be either eliminated 

or severely curtailed. Such lending should be done by the fiscal authorities 

only in emergencies and, if the Fed is involved, only upon the written request of the Treasury. Any non-Treasury securities or collateral acquired by 

the Fed under such lending should be promptly swapped for Treasury securities so that it is clear that the responsibility and accountability for such 

lending rests explicitly with the fiscal authorities, not the Federal Reserve. 

To codify this arrangement, I believe we should establish a new Fed-Treasury Accord. This would eliminate the ability of the Fed to engage in ‘bailouts’ of individual firms or sectors and place such responsibility with the 

Treasury and Congress, squarely where it belongs. 

Do you agree with President Plosser? 

A.1.a Since the fall of 2008, I have advocated that Congress establish a statutory resolution regime that provides a workable alternative to Government bailouts and disorderly bankruptcies. With 

enactment of a workable resolution regime for systemically important firms, I have also called for removal of the Federal Reserve’s 

authority under section 13(3) to extend credit to troubled nonbanking entities. 

However, I believe that it would be appropriate for the Federal 

Reserve to retain the authority to lend to establish broad marketbased credit facilities in unusual and exigent circumstances. In exceptional circumstances the preservation of financial stability may 

require that the Federal Reserve have the authority to provide liquidity to restart or encourage markets to operate, thereby providing liquidity needed to allow households, small businesses, depositors and others access to working liquid markets. The need for 

such authority was fully evident during the financial crisis, when 

preventing a financial catastrophe required that the Federal Reserve provide liquidity to money market mutual funds, primary 

dealers, the commercial paper market, and the market for student 

loans, credit card loans, small business loans and the commercial 

real estate market. 

Q.1.b. Do you believe that modifications to Section 13(3) of the 

Federal Reserve Act would be useful in clarifying emergency responses of various branches of government to financial crises? If so, 

what modifications do you believe would be most useful? 

A.1.b. Apart from a possible elimination of the authority to lend to 

single firms (as discussed above), I do not believe that significant 

modifications to section 13(3) are necessary or appropriate. The 

Federal Reserve has historically been extremely cautious in using 

the section 13(3) authority. 

Prior to the recent financial crisis, the Federal Reserve had authorized the extension of credit under section 13(3) in only one cir-
110 

cumstance since the Great Depression and had not in fact extended 

credit under this section since the 1930s. 

During this financial crisis, the Federal Reserve worked closely 

with the Department of the Treasury before exercising authority 

under section 13(3). We believe this consultation is important and 

appropriate and would not object to a statutory provision requiring 

consultation with or approval by the Secretary of the Treasury 

prior to authorizing an extension of credit under section 13(3). 

Q.1.c. Do you favor the establishment of a new Fed-Treasury Accord to provide greater distinction between fiscal policy actions and 

lender-of-last resort actions taken by the Federal Reserve in an 

emergency? 

A.1.c. The Federal Reserve and the Treasury have an accord that 

sets forth the principles applied by each in addressing the current 

crisis. We would favor a legislative provision allowing the Federal 

Reserve to transfer to the Treasury obligations that, while acquired 

in the course of Federal Reserve action as the lender of last resort, 

become fiscal obligations more appropriately managed by the 

Treasury Department. We would be happy to work with you on developing this type of approach. 

Interest on Reserves 

Q.2. Congress provided the authority to pay interest on reserves to 

the Board of Governors of the Federal Reserve, and not the Federal 

Open Market Committee (FOMC). Similarly, the Board of Governors, and not the FOMC, has authority over setting the discount 

rate and reserve requirements. According to minutes of the January 26–27, 2010, FOMC meeting, the interest rate paid on excess 

reserve balances (the IOER rate) is one of the tools available to 

support a gradual return to a more normal monetary policy stance. 

Quoting from the minutes: 

Participants expressed a range of views about the tools and strategy for removing policy accommodation when that step becomes appropriate. All 

agreed that raising the IOER rate and the target for the Federal funds rate 

would be a key element of a move to less accommodative monetary policy. 

• Are there any possible future conflicts or difficulties that you 

could imagine might arise from having the Federal Reserve’s 

target for the Federal funds rate determined by the FOMC 

while the IOER and discount rate are determined by the Board 

of Governors? 

• As it moves toward a more normal monetary policy stance, the 

Federal Reserve may use the IOER rate to help manage reserve balances. If the IOER rate, rather than a target for a 

market rate, becomes an indicator of the stance of monetary 

policy for a time, will the balance of power over monetary policy between the FOMC and the Federal Reserve Board change? 

A.2. As you know, the Congress has assigned to the Board the responsibility for determining the rate paid on reserves. Although the 

Federal Open Market Committee (FOMC) by law is responsible for 

directing open market operations, the Congress has also assigned 

to the Board the responsibility for determining certain other important terms that are relevant for the conduct of monetary policy— 

for example, the Board ‘‘reviews and determines’’ the discount rates 
111 

that are established by the Federal Reserve Banks; the Federal 

Open Market Committee has no statutory role in setting the discount rate. Similarly, the Board sets reserve requirements subject 

to the constraints established by the Congress; the Federal Open 

Market Committee has no statutory role in setting reserve requirements. 

For many years, the Board and the FOMC have worked collegially and cooperatively in setting the discount rate, the Federal 

funds target rate, and other instruments of monetary policy. I am 

convinced that the Board and the FOMC will continue to work cooperatively in the future in adjusting all of the instruments of monetary policy. 

Monetary Policy and Fiscal Policy Distinction 

Q.3.a. Several regional Federal Reserve bank presidents have expressed concern that actions taken by the Fed, many under Section 

13(3) authority, were actions to channel credit to specific firms or 

specific segments of financial markets and the economy. The concern is that some actions amounted to fiscal, and not lender of last 

resort, policies. Moreover, in a March 23, 2009 joint press release, 

the Fed and the Treasury stated the following: 

The Federal Reserve to avoid credit risk and credit allocation 

The Federal Reserve’s lender-of-last-resort responsibilities involve lending 

against collateral, secured to the satisfaction of the responsible Federal Reserve Bank. Actions taken by the Federal Reserve should also aim to improve financial or credit conditions broadly, not to allocate credit to narrowly defined sectors or classes of borrowers. Government decisions to influence the allocation of credit are the province of the fiscal authorities. 

In accord with the joint statement, should the Fed’s stock of 

agency debt and mortgage-backed securities along with its Maiden 

Lane holdings be swapped for Treasury securities, thereby transparently placing the channeling of credit support to the housing 

sector firmly in the hands of fiscal authorities? 

A.3.a. The Federal Reserve’s purchases of agency debt and mortgage-backed securities, and the credit it has extended to the Maiden Lane entities, arose for different reasons and deserve different 

treatment. 

The primary purpose of the Federal Reserve’s purchases of securities issued or guaranteed by Federal agencies was a monetary 

policy response intended to support the overall economy by providing support to the mortgage and housing sectors. The Federal 

Reserve believes that in routine circumstances the modes of government support for the housing sector should be determined by 

the Congress and carried out through agencies other than the Federal Reserve. 

For that reason, the Federal Reserve in recent decades minimized its participation in the agency securities markets. However, 

the highly strained financial market conditions of the past few 

years prevented the Federal Reserve’s monetary policy actions to 

lower interest rates from being fully transmitted to housing markets, as would have happened in more normal times, and the Federal Reserve’s ability to lower short-term interest rates further was 

constrained after short-term rates were lowered to essentially zero. 
112 

In the circumstances, the Federal Reserve initiated a program to 

purchase agency debt and mortgage-backed securities. 

The credit extensions to AIG and the Maiden Lane entities represent exercise of the Federal Reserve’s authority as lender of last 

resort. The Treasury Department is better suited to make the policy and management decisions that attend the longer term relationship with a nonbanking firm that requires government assistance. 

Accordingly, the Federal Reserve would support a transfer to the 

Treasury of its AIG and Maiden Lane credits. The issues regarding 

a possible swap of agency debt and MBS securities for Treasury securities are somewhat more complex and would require careful 

study. 

Q.3.b. The Fed has purchased over $1 trillion of agency mortgagebacked-securities and intends to complete purchases of $1.25 trillion of those securities by the end of March. To help finance those 

purchases, the Fed uses supplemental borrowing from the Treasury 

and issues interest-bearing reserve balances. In effect, the Fed is 

borrowing from the public, including banks, with promises to repay 

the borrowed sums plus interest. The Fed will continue that borrowing in order to hold on to its mortgage-backed securities until 

those assets gradually decline as they mature or are prepaid or 

sold. When the Fed effectively finances an enormous portfolio holding of a specific class of assets using interest bearing debt issued 

to the public, how is that not a fiscal policy exercise? 

A.3.b. Monetary policy and fiscal policy are different tools that both 

can be used to stimulate the economy. The purpose of the Federal 

Reserve’s large-scale asset purchases was primarily to apply macroeconomic stimulus by lowering longer-term interest rates and by 

improving financial market functioning; fiscal policy applies stimulus by adjusting overall government spending or revenues. Because the Federal Reserve’s large-scale asset purchases involved 

changes in the central bank’s balance sheet—and, in particular, the 

creation of a large volume of reserves, it is clear that the purchases 

were a monetary policy action. Moreover, the Federal Reserve’s decision to purchase a large volume of longer-term assets in the crisis 

was consistent with its statutory mandate to promote maximum 

employment and price stability, and it was clearly supported by its 

statutory authorities. These transactions can and will be unwound 

in a manner consistent with these same mandates. 

Systemic Risk Regulation 

Q.4.a. Your February 25, 2010, testimony identifies that the Fed 

is making fundamental changes in its supervision of bank holding 

companies to, in your words, ‘‘incorporate a macroprudential perspective that goes beyond the traditional focus on safety and soundness of individual institutions.’’ 

Could you precisely define what you mean by a ‘‘macroprudential 

perspective,’’ and what metrics guide that perspective? 

A.4.a. Our supervisory approach should better reflect our mission, 

as a central bank, to promote financial stability. As was evident in 

the financial crisis, complex, global financial firms can be profoundly interconnected in ways that can threaten the viability of 

individual firms, the functioning of key financial markets, and the 
113 

stability of the broader economy. A macroprudential perspective requires a more system-wide approach to the supervision of systemically critical firms that considers the interdependencies among 

firms and markets that have the potential to undermine the stability of the financial system. To that end, we have supported the 

creation of a council of regulators that would gather information 

from across the financial system, identify and assess potential risks 

to the financial system, and work with member agencies to address 

those risks. 

In our own supervisory efforts, we are reorienting our approach 

to some of the largest holding companies to better anticipate and 

mitigate systemic risks. For example, we expect to increase the use 

of horizontal reviews, which focus on particular risks or activities 

across a group of banking organizations. In doing so, we have 

drawn on our experience with the Supervisory Capital Assessment 

Program (SCAP), in which the Federal Reserve led a coordinated 

effort by the bank supervisors to evaluate on a consistent basis the 

capital needs of the largest banking institutions in an adverse economic scenario. Because the SCAP involved the simultaneous evaluation of potential credit exposures across all of the included firms, 

we were better able to consider the systemic implications of financial stress under an adverse economic scenario, in addition to the 

impact of an adverse scenario on individual firms. 

The SCAP also showed the benefits of drawing on the work of a 

wide range of staff—including supervisors, economists, and market 

and payments system experts—to comprehensively evaluate the 

risks facing financial firms. Going forward, the Federal Reserve is 

instituting a data-driven, quantitative surveillance mechanism that 

will draw on a similar range of staff expertise to provide an independent view of the risks facing large banking firms. As part of 

that effort, we are developing quantitative tools to help identify 

vulnerabilities at both the firm level and for the aggregate financial sector. We anticipate that these tools will incorporate macroeconomic forecasts, including spillover and feedback effects. We 

also expect to develop indicators of interconnectedness, which could 

encompass common credit, market, and funding exposures. The development of specific metrics will also depend, in part, on the availability of timely and comparable data from systemically important 

firms. 

Q.4.b. Does the Fed intend to redefine what regulators should regard as ‘‘safety and soundness?’’ 

A.4.b. Ensuring the safety and soundness of institutions has been 

a cornerstone of the Federal Reserve’s supervision program. The recent crisis has shown that large, interconnected firms can be buffeted by a market-driven crisis, magnifying weaknesses in risk 

management practices, and revealing capital and liquidity buffers 

calibrated to withstand institution-specific stress events to be insufficient. For this reason, leading supervisors in the United States 

and abroad are reviewing the prudential standards needed to ensure safety and soundness for individual firms and the financial 

system as a whole. The Federal Reserve is participating in a range 

of joint efforts to ensure that large, systemically critical financial 

institutions hold more and higher quality capital, improve their 
114 

risk-management practices, have more robust liquidity management, employ compensation structures that provide appropriate 

performance and risk-taking incentives, and deal fairly with consumers. 

We are working with our domestic and international counterparts to develop capital and prudential requirements that take account of the systemic importance of large, complex firms whose failure would pose a significant threat to overall financial stability. 

Options under consideration include assessing a capital surcharge 

on these institutions or requiring that a greater share of their capital be in the form of common equity. For additional protection, systemically important institutions could be required to issue contingent capital, such as debt-like securities that convert to common 

equity in times of macroeconomic stress or when losses erode the 

institution’s capital base. U.S. supervisory agencies have already 

increased capital requirements for trading activities and 

securitization exposures, two of the areas in which losses were especially high. 

Liquidity requirements should also be strengthened for systemically critical firms, as even solvent financial institutions can be 

brought down by liquidity problems. The bank regulatory agencies 

are implementing strengthened guidance on liquidity risk management and weighing proposals for quantitatively based requirements. In addition to insufficient capital and inadequate liquidity 

risk management, flawed compensation practices at financial institutions also contributed to the crisis. Compensation should appropriately link pay to performance and provide sound incentives. The 

Federal Reserve has issued proposed guidance that would require 

banking organizations to review their compensation practices to ensure they do not encourage excessive risk-taking, are subject to effective controls and risk management, and are supported by strong 

corporate governance including board-level oversight. 

Federal Reserve’s Asset Holdings 

Q.5. Charles Plosser, President of the Federal Reserve Bank of 

Philadelphia, stated in a recent speech that 

. . . the Fed could help preserve its independence by limiting the scope of 

its ability to engage in activities that blur the boundary lines between monetary and fiscal policy. Thus, as the economic recovery gains strength and 

monetary policy begins to normalize, I would favor our beginning to sell 

some of the agency mortgage-backed securities from our portfolio rather 

than relying only on redemptions of these assets. Doing so would help extricate the Fed from the realm of fiscal policy and housing finance. 

Do you agree with President Plosser? 

A.5. I provided my views on asset sales in my March 25, 2010, testimony before the House Committee on Financial Services. The relevant passage is reproduced below. 

When these tools [reverse repurchase agreements and term deposits] are used to drain reserves from the banking system, they 

do so by replacing bank reserves with other liabilities; the asset 

side and the overall of the Federal Reserve’s balance sheet remain 

unchanged. If necessary, as a means of applying monetary restraint, the Federal Reserve also has the option of redeeming or 

selling securities. The redemption or sale of securities would have 
115 

the effect of reducing the size of the Federal Reserve’s balance 

sheet as well as further reducing the quantity of reserves in the 

banking system. Restoring the size and composition of the balance 

sheet to a more normal configuration is a longer-term objective of 

our policies. In any case, the sequencing of steps and the combination of tools that the Federal Reserve uses as it exits from its currently very accommodative policy stance will depend on economic 

and financial developments and on our best judgments about how 

to meet the Federal Reserve’s dual mandate of maximum employment and price stability. 

Treasury Financing Account at the Fed 

Q.6. On February 23, 2010, the Treasury announced, rather suddenly and surprisingly, and without much explanation, that it anticipates increasing its Supplementary Financing Account at the 

Fed by around $200 billion over the next 2 months. This means, 

essentially, that the Treasury will borrow on behalf of the Fed and 

simply hold the funds in the Treasury’s account at the Fed. I understand that the Treasury’s Supplementary Financing Program 

helps the Fed absorb reserves from the banking system and manage its balance sheet. I wonder, however, about the lack of information concerning why the Treasury suddenly decided to increase its 

balance at the Fed. 

• Was the Treasury’s February 23 announcement planned in advance and coordinated with the Fed, or was it a surprise to the 

Fed? 

• What are the future plans for the size of the Treasury’s Supplemental Financing Account? 

• Who will decide what will be the future balances in the Supplemental Financing Account? 

A.6. The Treasury and the Federal Reserve consulted closely on the 

Treasury’s February 23 announcement regarding the Supplementary Financing Program. However, the Treasury makes all decisions on balances to be held in the Supplementary Financing Account. 

Efforts to Toughen Capital and Liquidity Requirements 

Q.7.a. Your testimony on February 25, 2010 identifies that 

. . . the Federal Reserve has been playing a key international role in 

international efforts to toughen capital and liquidity requirements for financial institutions, particularly systemically critical firms . . . 

Could you describe what those efforts have been? 

A.7.a. The Federal Reserve has an active leadership role within the 

Finance Stability Board, the Basel Committee for Banking Supervision, and various other international supervisory fora. Through 

these fora, especially the Basel Committee, the Federal Reserve 

has worked diligently with supervisors from around the world to 

develop a comprehensive series of reforms to address the lessons 

that we have learned from the recent global financial crisis. The 

goal of the Basel Committee’s reform package is to improve the 

international banking sector’s ability to deal with future economic 

and financial stress, thus reducing the contagion risk from the financial sector to the real economy. 
116 

1See ‘‘Strengthening the resilience of the banking sector-consultative document’’ (December 

2009), available at www.bis.org/publ/bcbs164.htm. 2See ‘‘Report and recommendations of the Cross-border Bank Resolution Group-final paper’’ 

(March 2009), available at www.bis.org/publ/bcbs169.htm. 

The Federal Reserve co-chairs three Basel Committee working 

groups that are focusing on reforms especially pertinent to systemically important institutions. These groups are developing: a) revisions to the capital regulations for trading book activities, designed 

to enhance risk measurement and to significantly increase the capital requirement associated with various financial instruments that 

contributed to losses at systemically important institutions during 

the crisis; b) enhanced and higher capital charges for counterparty 

credit risk, including a new charge for credit valuation allowances 

(CVA), which were a significant source of loss during the crisis; and 

c) new liquidity standards, which directly address a major challenge during the global turmoil. With regard to the latter, the proposed standards draw heavily from conceptual design work contributed by Federal Reserve staff. In addition, Federal Reserve staff 

made significant contributions to the Basel Committee’s Principles 

for Sound Liquidity Risk Management and supervision issued in 

September 2008. In many cases, the international principles articulated drew heavily from established Federal Reserve guidance. 

Moreover, Federal Reserve economists and supervisors have been 

heavily involved in work conducted by the Basel Committee and by 

the Committee of Global Financial Stability to develop forwardlooking measures of systemic liquidity risks and in assessing the 

current state of funding and liquidity risk management at internationally active financial institutions. 

Federal Reserve staff also are key players in the Basel Committee’s working groups developing a new international leverage ratio 

standard, which is largely inspired by the U.S. leverage standard, 

and a new definition of regulatory capital for banking organizations, which is an area where the Federal Reserve provides insightful experience since almost all banking capital issuance in the U.S. 

is executed at the bank holding company level.1 Moreover, the Federal Reserve has also played an active role in the Basel Committee’s working group that recently issued recommendations to 

strengthen the resolution of systemically significant cross-border 

banks.2

Q.7.b. Could you define a ‘‘systemically critical’’ firm and identify 

how many such firms currently operate in the United States? 

A.7.b. A ‘‘systemically critical’’ firm is one whose failure would 

have significant adverse effects on financial markets or the economy. At any point in time, the systemic importance of an individual 

firm depends on a wide range of factors including whether the firm 

has extensive on- and off-balance sheet activities, whether the firm 

is interconnected—either receiving funding from, or providing funding to other systemically important firms—whether the firm plays 

a major role in key financial markets, and/or whether the firm provides crucial services to its customers that cannot easily or quickly 

be provided by other financial institutions. That said, the identification of systemic importance requires considerable judgment because each stress event is different, because market structure, 

business practices, financial products, technologies, supervisory 
117 

practices and regulatory environments evolve over time. This evolution, of course, changes the interconnections between firms, their 

relative sizes, their functions and services, and the extent to which 

services can be obtained from other firms or in financial markets. 

As a practical matter, it is likely that the number of firms that are 

considered systemically critical will be less than 50. For example, 

only about 35 U.S. financial firms, with publicly traded stock outstanding, have total assets over $100 billion as of 2008:Q4. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BROWN 

FROM BEN S. BERNANKE 

Bank Lending 

Q.1. I have heard from Ohio banks that banking regulators are 

preventing them from expanding commercial lending by requiring 

them to maintain greater capital reserves. I agree that we need to 

ensure that our banks are well capitalized, but at some point we’ve 

got to get lending going again, particularly to businesses that will 

use their money to hire workers. 

How can banks strike a balance between being well capitalized 

and still lending like they are supposed to? 

A.1. The loss absorbing characteristics of capital provide the economic bedrock that supports prudent bank lending and, as such, it 

is not inconsistent for banks to remain well capitalized and concomitantly engage in healthy lending practices. However, during 

the financial crisis, many banks recorded significant financial 

losses that eroded their capital base and as a result, some banks 

may be operating with reduced capital bases to support lending activities. In other instances, well capitalized banks may be reluctant 

to lend if their outlook on economic conditions lead them to believe 

that additional losses are likely in the near term, which would further erode their current capital position. The Federal Reserve believes that, in cases where banks are concerned about potential additional losses, a prudent response would be for those banks to increase their capital position in order to address this concern and 

to take advantage of any demand in commercial lending. Likewise, 

we believe that an improving economic outlook should help banks 

to bolster their capital levels and contribute to increased willingness of banks to lend. 

Q.2. Have you considered taking any specific steps, like lowering 

the Fed’s interest payments on excess bank reserves, or perhaps 

even imposing a penalty on hoarding money, to promote greater 

lending? 

A.2. The Federal Reserve’s payment of interest on excess reserves 

is unlikely to be a significant factor in banks’ current reluctance to 

lend. The Federal Reserve is currently paying interest at a rate of 

only one quarter of 1 percent on banks’ reserve balances. By contrast, the prime rate is currently at 3 1⁄4 percent, and many bank 

lending rates are considerably higher than the prime rate. Given 

the large difference between the interest rate paid on excess reserves and the interest rates on banks, the ability to earn interest 

on excess reserves is unlikely to be an important reason for the 

tightening of banks’ lending standards and terms over the past few 
118 

years. Indeed, survey results suggest that the major reason that 

banks have tightened lending terms and standards over the past 

2 years or so was their concern about the economic outlook. As you 

know, the Federal Reserve has acted aggressively from the outset 

of the financial crisis to stabilize financial market conditions and 

promote sustainable economic growth. An improving economic outlook should contribute to increased willingness of banks to lend. 

Bank Concentration 

Q.3. Banks are borrowing at record low interest rates—particularly 

those banks that are viewed as ‘‘too big to fail.’’ According to the 

Center for Economic and Policy Research, the 18 biggest banks are 

getting what amounts to a $34.1 billion a year subsidy because of 

their implicit government guarantee. More recent data from the 

FDIC shows that big banks are turning a profit, but small banks 

are not. Data from 1999 shows that large banks’ fees for overdrafts 

are 41 percent higher than at small banks and bounced check fees 

are 43 percent higher. Now borrowers are having their lines of 

credit slashed and their bank fees are still increasing. 

So it appears that consumers and small banks are suffering, 

while the big banks thrive. And the market is only getting more 

concentrated: 319 banks were forced to merge or fail in 2009. 

What steps are the Fed taking to ensure that there is not excessive concentration in the banking industry, and that consumers are 

being well served through meaningful competition? 

A.3. The Riegle-Neal Interstate Banking and Branching Efficiency 

Act (IBBEA) of 1994 provides prudential protection against excessive concentration in the banking industry by prohibiting the Federal Reserve from approving a bank acquisition that would result 

in a bank holding company exceeding a nationwide deposit concentration limitation of more than 10 percent of the total amount 

of deposits of insured depository institutions in the United States. 

Notwithstanding that protection, there are many other potential 

methods to address the subsidies that may arise because of perceptions that large financial firms are ‘‘too-big-to-fail.’’ For example, 

firms that might reasonably be considered ‘‘too-big-to-fail’’ may be 

subject to higher capital (and liquidity) requirements, more highly 

tailored resolution mechanisms, tighter deposit share caps, required issuance of contingent capital instruments and/or subordinated debt instruments, limitations on, or a ban of, certain activities (e.g., hedge funds or private equity funds), and taxes on nondeposit balance-sheet liabilities. As the financial crisis winds down, 

many of these types of proposals to reduce the subsidies that arise 

from implicit guarantees are under consideration in the United 

States and abroad. In fact, Federal Reserve staff are participating 

on many international working groups that are considering the potential effects, including unintended consequences, that may arise 

from implementing such proposals either singularly, or in combination. A key factor in such analyses is the impact on competition 

here in the United States and internationally across borders. 

Research on whether consumers benefit from ‘‘too-big-to-fail’’ subsidies is scant. It is plausible that large financial institutions might 

pass along some of their subsidies to consumers to fuel their own 
119 

growth at the expense of smaller peers. Some evidence, however, 

suggests otherwise. For example, Passmore, Burgess, Hancock, 

Lehnert, and Sherlund (in a presentation at the Federal Reserve 

Bank of Chicago Bank Structure Conference, May 18, 2006) estimate that just 5 percent of the Fannie Mae and Freddie Mac’s borrowing advantage flowed through to mortgage rates, resulting in 

just a few basis points reduction in conforming mortgage loan 

rates. Even if financial firms do not pass along their ‘‘too-big-tofail’’ subsidies to consumers, it does not necessarily imply that they 

cannot pass along the higher costs that would result from the reduction of such subsidies. Indeed, larger firms may set the market 

prices for some financial products because of other cost advantages 

associated with their size. In such circumstances, consumers may 

end up paying higher prices when ‘‘too-big-to-fail’’ subsidies are reduced (or eliminated) even though they did not previously much 

benefit from such subsidies. That said, all consumers benefit from 

a more stable financial system with less systemic risk and this is 

the goal of reducing or eliminating ‘‘too-big-to-fail’’ subsidies. 

Resolution of Failed Banks 

Q.4. You have previously said that you favor ‘‘establishing a process that would allow a failing, systemically important non-bank financial institution to be wound down in any orderly fashion, without jeopardizing financial stability.’’ There’s been a lot of talk about 

whether this job should be done by banking regulators or a bankruptcy court. 

Do you have an opinion about this, particularly whether the 

FDIC is doing a good job with its resolution authority? 

A.4. In most cases, the Federal bankruptcy laws provide an appropriate framework for the resolution of nonbank financial institutions. However, the bankruptcy code does not sufficiently protect 

the public’s strong interest in ensuring the orderly resolution of a 

nonbank financial firm whose failure would pose substantial risks 

to the financial system and to the economy. 

A new resolution regime for systemically important nonbank financial firms, analogous to the regime currently used by the Federal Deposit Insurance Corporation for banks, would provide the 

government the tools to restructure or wind down such a firm in 

a way that mitigates the risks to financial stability and the economy and thus protects the public interest. It also would provide the 

government a mechanism for imposing losses on the shareholders 

and creditors of the firm. Establishing credible processes for imposing such losses is essential to restoring a meaningful degree of 

market discipline and addressing the ‘‘too-big-to-fail’’ problem. 

It would be appropriate to establish a high standard for invocation of this new resolution regime and to create checks and balances on its potential use, similar to the provisions governing use 

of the systemic risk exception to least-cost resolution in the Federal 

Deposit Insurance Act (FDI Act). The Federal Reserve’s participation in this decisionmaking process would be an extension of our 

long-standing role in protecting financial stability, involvement in 

the current process for invoking the systemic risk exception under 

the FDI Act, and status as consolidated supervisor for large banking organizations. The Federal Reserve, however, is not well suited, 
120 

nor do we seek, to serve as the resolution agency for systemically 

important institutions under a new framework. Because the suitability of an entity to serve as the resolution agency for any particular firm may depend on the firm’s structure and activities, the 

Treasury Department should be given flexibility to appoint a receiver that has the requisite expertise to address the issues presented by a wind down of that firm. 

Banks Trading Commodities Futures Derivatives 

Q.5. You gave an address at Harvard in 2008 in which you talked 

about out-of-control crude oil prices. You said that ‘‘demand growth 

and constrained supplies’’ were responsible for ‘‘intense pressure on 

[gas] prices.’’ Senator Carl Levin investigated the crude oil market 

and found that speculation ‘‘appears to have altered the historical 

relationship between [crude oil] price and inventory.’’ In 2003, at 

the request of Citigroup and UBS, the Fed authorized bank holding 

companies to trade energy futures, both on exchanges and over-thecounter. 

Given that commodity prices affect the Consumer Price Index, 

which affects inflation, have you investigated what effect the rule 

change, and the resulting investments in commodities futures and 

other commodities-related derivatives, have had on oil prices? 

Q.6. If not, how can you conclude that rises in gasoline prices are 

due solely to simple changes in supply and demand? 

Q.7. If presented with evidence that energy speculation was driving 

up prices or affecting inflation, would you consider revoking the 

banks’ authority to trade energy futures? 

A5.–7. The broad movements in oil and other commodity prices 

have been in line with developments in the global economy. They 

rose when global growth was strong and supply was constrained. 

and they collapsed with the onset of the global recession. As the 

global economy began to recover and financial conditions began to 

normalize, commodity prices rebounded. 

Nonetheless, the extreme price swings, particularly in the case of 

oil, have been surprising. Some have argued that speculative activities on the part of financial investors have been responsible for 

these outsized price movements. Notwithstanding considerable 

study, however, conclusive evidence of the role of speculators and 

financial investors remains elusive. The fundamentals of supply 

and demand, along with expectations for how these fundamentals 

will evolve in the future, remain the best explanation for the movements in commodity prices. That said, we must remain open to 

other possibilities, and if conclusive evidence emerged that commodity markets were not performing their price discovery and 

allocative role effectively, then changes in regulatory policies may 

be appropriate. 

Fed Purchases of Foreign Currency Derivatives 

Q.8. In the wake of the Greek debt crisis, I’m concerned about governments’ use of foreign currency exchanges—that other governments might be using foreign currency swaps to mask their debt, 

or for other purposes. We know that the Federal Reserve entered 

into swaps with Foreign Central Banks and then those Foreign 
121 

Central Banks bailed out their own banking systems. For example, 

the Federal Reserve worked with the Swiss central bank on the 

rescue effort for UBS, securing dollars through a swap agreement 

for francs. As of December 31, 2008, the United States had entered 

into $550 billion in liquidity swaps with foreign central banks. 

How are these arrangements between the Federal Reserve and 

the other central banks structured? 

A.8. The dollar liquidity swap arrangements that the Federal Reserve entered into with foreign central banks were fundamentally 

different from the currency swaps that have been discussed in the 

Greek context. According to reports, the Greek cross-currency 

swaps were highly structured arrangements initiated 8 or 9 years 

ago between the government of Greece and a private sector financial institution. These swaps apparently entailed payment obligations over a period of 15 to 20 years with large balloon payments 

at maturity, and they allowed the Greek government to exchange 

into euros the proceeds of borrowing it had done in Japanese yen 

and U.S. dollars at off-market rates of exchange. 

The dollar liquidity swaps, the volume of which is now zero following the termination of the arrangements in February, were 

more straightforward, shorter-term arrangements with foreign central banks of the highest credit standing. In each dollar liquidity 

swap transaction, the Federal Reserve provided U.S. dollars to a 

foreign central bank in exchange for an equivalent amount of funds 

in the currency of the foreign central bank, based on the market 

exchange rate at the time of the transaction. The parties agreed to 

swap back these quantities of their two currencies at a specified 

date in the future, which was at most 3 months ahead, using the 

same exchange rate as in the initial exchange. The Federal Reserve 

also received interest corresponding to the maturity of the swap 

drawing. 

Because the terms of each swap transaction were set in advance, 

fluctuations in exchange rates following the initial exchange did 

not alter the eventual payments. Accordingly, these swap operations carried no exchange rate or other market risks. In addition, 

we judged our swap line exposures to be of the highest quality and 

safety. The foreign currency held by the Federal Reserve during 

the term of the swap provided an important safeguard. Furthermore, our exposures were not to the institutions ultimately receiving the dollar liquidity in the foreign countries but to the foreign 

central banks. We have had long and close relationships with these 

central banks, many of which hold substantial quantities of U.S. 

dollar reserves in accounts at the Federal Reserve Bank ofNew 

York, and these dealings provided a track record that justified a 

high degree of trust and cooperation. The short tenor of the swaps, 

which ranged from overnight to 3 months at most, also offered 

some protection, in that positions could be wound down relatively 

quickly were it judged appropriate to do so. 

Q.9. Are these swaps being used in any way to mask U.S. Government debt? 

A.9. No. These swaps were limited to the exchange of U.S. dollar 

liquidity for foreign-currency liquidity and were not used in any 

way to mask U.S. Government debt. 
122 

Q.10. Does the Federal Reserve keep track of which foreign banks 

ultimately receive U.S. money from foreign central banks? If so, 

what banks have gotten U.S. money, and how much has each gotten? 

A.10. The Federal Reserve’s contractual relationships were with 

the foreign central banks and not with the financial institutions ultimately obtaining the dollar funding provided by these operations. 

Accordingly, the Federal Reserve did not track the names of the institutions receiving the dollar liquidity from the foreign central 

banks but instead left to the foreign central banks the responsibility for managing the distribution of the dollar funding. This responsibility included determining the eligibility of institutions that 

could participate in the dollar lending operations, assessing the acceptability of the collateral offered, and bearing any residual credit 

risk that might have arisen as a result of the lending operations. 

Q.11. Is the U.S. Treasury issuing Treasury bonds which the Fed 

is then buying through the U.K. or other foreign governments? 

A.11. No. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR MERKLEY 

FROM BEN S. BERNANKE 

Q.1. The homeownership rate in Canada is almost identical to that 

of the United States. Yet the percentage of U.S. mortgages in arrears is fast approaching 10 percent while the percentage of Canadian mortgages in arrears has been relatively stable for the past 

two decades at less than 1 percent. What characteristics of the 

mortgage market in Canada do you believe have helped that country avoid a similar foreclosure crisis? 

A.1. A number of characteristics of the Canadian mortgage market 

helped Canada avoid a foreclosure crisis. Canadian homeowners 

typically maintain greater equity in their homes, in part because 

mortgage insurance, which is required when loan-to-value ratios 

exceed 80 percent, is more costly than in the United States. Moreover, Canadian mortgages are subject to substantial pre-payment 

penalties, reducing the incentives of households to regularly refinance their mortgages. While in general this limits households’ 

ability to take advantage of falling interest rates, it also reduces 

the number of ‘‘cash out’’ refinancings, increasing the average equity held by households. 

In addition, a greater fraction of Canadian mortgages are prime 

mortgages, which default at lower rates than sub-prime mortgages. 

One reason the sub-prime market was slower to grow in Canada 

is because of the incentives, noted above, for borrowers to make 

higher down payments. Another reason is that a smaller fraction 

of mortgages in Canada are securitized, because even mortgages 

that have been securitized and resold carry a capital charge, giving 

Canadian banks less incentive to securitize mortgages. A mortgage 

lender that plans to hold a mortgage to maturity likely employs 

higher underwriting standards than a mortgage lender that plans 

to securitize the loan. 

Finally, Canada has experienced a comparatively milder labormarket downturn than the United States and only a modest de-
123 

1To be considered ‘‘well capitalized’’ under the U.S. Prompt Corrective Action (PCA) requirements, a bank must have a Tier 1 Leverage ratio of no less than 5 percent, a Tier I risk-based 

capital ratio of no less than 6 percent, a Total risk-based capital ratio of no less than 10 percent. 

cline in house prices. These factors, too, have helped reduce the incidence of default. 

Q.2. All of the six major banks in Canada own investment banking 

and insurance subsidiaries. All five of the major banks in Canada 

would probably be considered ‘‘too-big-to-fail.’’ However, the Canadian banking regulators have prudently enforced more stringent 

capital requirements including a 7 percent minimum of Tier 1 capital and 10 percent minimum of total capital. Additionally, there is 

an Assets-to-Capital Multiple maximum of 20 (or leverage ratio). 

What lessons have you learned from observing the actions that 

Canadian regulators have taken regarding the use of more stringent capital requirements than those required under Basel II? 

A.2. At present, the U.S. regulatory capital rules result in a requirement for banking organizations to hold capital at levels that 

are equal to, or exceed, Canadian peers; notwithstanding that the 

stated required minimum Tier 1 risk-based capital ratio is 6 percent for ‘‘well capitalized’’ banks under PCA.1 Because of statutorily required responses to the breeching of a PCA capital threshold, market forces generally necessitate banks and bank holding 

companies to hold substantially more capital than the ‘‘well capitalized’’ ratio requirements to ensure that significant losses can be absorbed before a ‘‘well capitalized’’ ratio is breached. The following 

table outlines the Tier I, Total and Leverage ratios of the top six 

U.S. bank holding companies and provides our estimate of their respective Assets-to-Capital Multiple as computed under the Canadian regulatory capital regime. As shown below, each of the top six 

U.S. bank holding companies would easily exceed the Canadian 

standards outlined above. 

Selected Capital Ratios 

Six Largest U.S. Bank Holding Companies 

(as of December 31, 2009) 

Tier 1 RiskBased Capital Total RiskBased Capital Tier 1 Leverage Ratio 

Assets-to-Tier 

1 Capital 

Multiple 

(Inverse of 

U.S. Leverage 

Ratio) 

Assets-toCapital Multiple 

(Canadian 

Definition) 

Bank of America ............................................. 10.41% 14.67% 6.91% 14.5 11.6 

JP Morgan Chase ............................................ 11.10% 14.78% 6.88% 14.5 13.7 

Citigroup ......................................................... 11.67% 15.25% 6.89% 14.5 12.7 

Wells Fargo ..................................................... 9.25% 13.26% 7.87% 12.7 9.6 

Goldman Sachs ............................................... 14.97% 18.17% 7.55% 13.2 12.3 

Morgan Stanley ............................................... 15.30% 16.38% 5.80% 17.2 17.1 

The Federal Reserve believes that, going forward, capital requirements will need to be recalibrated to directly address the inappropriate incentives that were the underlying causes of the financial crisis. We are engaged in a significant effort both here in 

the United States and abroad to achieve this objective. 

Q.3. Canada has an independent consumer protection agency, 

called the Consumer Financial Agency of Canada. Do you believe 
124 

that this agency’s mission and independence has helped the Canadian financial markets remain stable and well capitalized, even 

under the current economic conditions? 

A.3. Consumer protection laws are very important for maintaining 

a well-functioning financial system. The Financial Consumer Agency of Canada (FCAC) is responsible for ensuring compliance with 

consumer protection laws and regulations; monitoring financial institutions’ compliance with voluntary codes of conduct; and informing consumers of their rights and responsibilities as well as providing general information on financial products. 

Ensuring compliance with consumer protection laws is an important defense against future financial problems, and informed consumers are undoubtedly less likely to enter unfavorable mortgage 

agreements. It is difficult to gauge, however, the extent to which 

the quality of consumer information and extent of consumer protection help explain why Canada had relatively few of the exotic, 

hard-to-understand sub-prime mortgages that have had such high 

default rates in the United States. As noted in the answer to the 

preceding question, other factors—the structure of the mortgage 

market and bank capital regulation in Canada—appear to represent more tangible reasons why the sub-prime market was slow 

to develop in Canada. 

Q.4. Throughout the past year, many witnesses before the Senate 

Banking Committee have argued that the widespread practice of 

securitizing mortgages helped propagate bad underwriting practices and contributed to the toxic nature of many, if not all, investments in subprime mortgages. The Canadian mortgage market 

only has approximately 5 percent of outstanding mortgages categorized as ‘‘subprime.’’ Additionally, according to the Bank of Canada, 68 percent of mortgages remain on the balance sheet of the 

lender and most residential mortgage financing is funded through 

deposits. Do you think that banks who keep major portions of their 

residential real estate lending ‘‘on the books’’ are less likely to engage in the financing of, ‘‘subprime’’ mortgage lending? 

A.4. It is unlikely that a requirement to keep mortgage exposures 

on balance sheet would make banking organizations less likely to 

underwrite ‘‘subprime’’ exposures. For instance, prior to the financial crisis, many banking organizations entered into ‘‘subprime’’ 

mortgage securitizations and retained the ‘‘first loss’’ positions ‘‘on 

the books,’’ reflecting a high risk tolerance for exposure to the 

‘‘subprime’’ mortgage market. Additionally, many other banking organizations provided recourse on ‘‘subprime’’ mortgage exposures 

that they sold to securitization structures; again, a reflections of a 

high risk tolerance ‘‘subprime’’ mortgage exposures. If banking organizations were no longer allowed to place ‘‘subprime’’ mortgages 

into securitization vehicles, it could be reasonably posited that 

banking organizations would continue to underwrite ‘‘subprime’’ 

mortgages given the higher yield earned from these exposures and 

the fact that the current risk-based capital framework levies an 

identical capital requirement for a ‘‘subprime’’ exposure as it does 

for a ‘‘prime’’ exposure. 

There are several distinct differences between the U.S. and Canadian mortgage markets that raise difficulty in using the Cana-
125 

dian experience as a comparator. For example, the Canada Mortgage and Housing Corporation (CMHC), which serves a similar 

function as Freddie and Fannie, is guaranteed by the full faith and 

credit of Canada, in the same manner as GNMA is guaranteed by 

the United States. As a result, banking organizations that invest 

in securitization structures through the CMHC are required to hold 

no regulatory capital against their investment (0 percent riskweight exposure), versus in the United States where banking organizations must risk-weight exposures to Freddie or Fannie at 20 

percent. In addition, Canadian banking organizations are required 

to obtain private mortgage insurance (PMI) for all mortgages with 

a loan-to-value ratio over 80 percent and they must maintain the 

PMI for the life of the loan, regardless of any subsequent reduction 

in a mortgage’s LTV that may result from loan repayment or house 

appreciation. However, banks that rely on private mortgage insurers receive a government guarantee against losses that exceed 10 

percent of the original mortgage in the event of an insurer failure. 

As a result, Canadian banking organizations are required to hold 

relatively little capital against mortgage exposures that are held on 

balance sheet—either through on-balance sheet mortgage portfolios 

or through investments in CMHC securitizations. 

The market for ‘‘subprime’’ mortgages was all but ended for Canadian banking organizations in 2008 when the CMHC decided to 

no longer insure ‘‘subprime’’ mortgages. This provided a significant 

regulatory capital disincentive for Canadian banking organizations 

to underwrite ‘‘subprime’’ mortgages. 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR BUNNING 

FROM BEN S. BERNANKE 

Q.1. Treasury recently announced they were starting up the Supplemental Financing Program again. Under that Program, Treasury issues debt and deposits the cash with the Fed. That is effectively the same thing as the Fed issuing its own debt, which is not 

allowed. What are the legal grounds the Fed and Treasury use to 

justify that program? And did anyone in the Fed or Treasury raise 

objections when the program was created? 

A.1. Section 15 of the Federal Reserve Act requires the Federal Reserve to act as fiscal agent for the United States and authorizes the 

Treasury to deposit money held in the general fund of the Treasury 

in the Federal Reserve Banks. Balances held by the Reserve Banks 

in the Treasury’s Supplementary Financing Account (SFA) are deposited and held under this authority. Although the Treasury and 

the Federal Reserve have consulted closely on matters regarding 

the Supplemental Financing Program (SFP), the Treasury makes 

all decisions on balances to be held in the SFA. 

I am not aware of any staff member or policymaker raising legal 

objections to the creation of the SFP. However, at least one Federal 

Reserve policymaker has publicly expressed policy concerns with 

the SFP. See Real Time Economics, WSJ Blogs, ‘‘Q&A: Philly Fed’s 

Plosser Takes on ‘Extended Period’ Language,’’ March 1, 2010. 

Q.2. Given what you learned during the AIG crisis and bailout, do 

you think Congress should be doing something to address insurance regulation or the commercial paper market? 
126 

A.2. The financial crisis has made clear that all financial institutions that are so large and interconnected their failure could 

threaten the stability of the financial system and the economy 

must be subject to consolidated supervision. Lack of strong consolidated supervision of systemically critical firms not organized as 

bank holding companies, such as AIG, proved to be a serious regulatory gap. The Federal Reserve strongly supports ongoing efforts 

in the Congress to reform financial regulation and close existing 

gaps in the regulatory framework. 

An effective framework for financial supervision and regulation 

also must address macroprudential risks—that is, risks to the financial system as a whole. The disruptions in the commercial 

paper market following the failure of Lehman Brothers on September 15, 2008 and the breaking of the buck by a large money 

fund the following day are examples of such macroprudential risks. 

Legislative proposals in both the House and Senate would also 

improve the exchange of information and the cross-fertilization of 

ideas by creating an oversight council composed of representatives 

of the agencies and departments involved in the oversight of the financial sector that would be responsible for monitoring and identifying emerging systemic risks across the full range of financial institutions and markets. The council would have the ability to coordinate responses by member agencies to mitigate identified 

threats to financial stability and, importantly, would have the authority to recommend that its member agencies, either individually 

or collectively, adopt heightened prudential standards for the firms 

under the agencies’ supervision in order to mitigate potential systemic risks. 

Q.3.a. When did you know that AIG’s swaps partners were going 

to be paid off at effectively par value in the Maiden Lane 3 transaction? 

Q.3.b. Did you or the Board approve the payments? 

A.3.a.–b. I was not directly involved in the negotiations with the 

counterparties that sold multi-sector collateralized debt obligations 

(‘‘CDOs’’) to Maiden Lane III LLC (‘‘ML III’’) in return for termination of credit default swaps AIG had written on those CDOs. 

These negotiations were handled by the staff of the Federal Reserve Bank of New York (‘‘FRBNY’’). I participated in and support 

the final action of the Board to authorize lending by the FRBNY 

to ML III for the purpose of purchasing the CDOs in order to remove an enormous obstacle to AIG’s financial stability and thereby 

help prevent a disorderly failure of AIG during troubled economic 

times. 

As explained in the testimony of Thomas Baxter, Executive Vice 

President and General Counsel, FRBNY, before the Committee on 

Oversight and Government Reform on January 27, 2010, the Federal Reserve loan to ML III was used by ML III to purchase the 

multi-sector CDOs underlying AIG’s CDS at their current market 

value (approximately $29 billion), which represented a significant 

discount to their par value ($62 billion). Collateral already posted 

by AIG (not ML III) under the terms of the CDS contracts was also 

relinquished by AIG in return for tearing-up the contracts and freeing AIG of further obligations under the CDS contracts. Before 
127 

agreeing to the transaction, the Federal Reserve consulted independent financial advisors to assess the value of the underlying 

CDOs and the expectation that the value of the CDOs would be recovered. The advisors believed that the cash flow and returns on 

the CDOs would be sufficient, even under highly stressed conditions, to fully repay the Federal Reserve’s loan to ML III. Under 

the terms of the agreement negotiated with AIG, the Federal Reserve will also receive two-thirds of any profits received on the 

CDOs after the Federal Reserve’s loan and AIG’s subordinated equity position are repaid in full. 

Q.3.c. When did you find out about the cover-up of the amount of 

the payments? 

Q.3.d. Did you approve of the efforts to cover up the amount of the 

payments? 

Q.3.e. If you did not approve of the cover-up at the time, do you 

believe that it was the right decision? 

A.3.c.–e. The amount of the payments to the CDS counterparties 

was fully disclosed by AIG. Moreover, the Federal Reserve fully disclosed the amount of its loan to ML III and the fair value of the 

assets that serve as collateral for that loan in both the weekly balance sheet of the Federal Reserve (available on the Board’s 

website) and in the Board’s reports to Congress as required by law. 

AIG was at all times responsible for complying with the disclosure requirements of the various securities laws. I was not involved 

in the discussions between the Federal Reserve and AIG related to 

AIG’s securities law filings. I fully supported AIG’s decision to release publicly in March 2009 the identities of these counterparties. 

Q.4. The Fed has been out in the press talking about how they are 

going to make money on their AIG loans, making it sound like a 

good deal for the taxpayers. However, that is not the whole story 

because Treasury has committed some $70 billion to the AIG bailout. So the taxpayers are still exposed to AIG, and in fact are likely 

to take losses. Do you agree that the Fed’s exposure to AIG is not 

the whole story and the taxpayers are likely to face losses from the 

AIG bailout? 

A.4. As you know, the Federal Reserve provided liquidity to AIG 

through direct line of credit and through loans provided to two 

Maiden Lane facilities that funded certain assets of AIG. Extensive 

information about each of these credits is available on the Board’s 

website and in reports and testimony provided by the Federal Reserve to Congress. Based on analysis of the collateral supporting 

these loans by experienced third-party advisors and the FRBNY, 

the Federal Reserve expects to be fully repaid on each of these 

credits, with no loss to the taxpayers. 

The Treasury Department has provided equity to AIG. Like the 

liquidity provided by the Federal Reserve, this equity was provided 

in order to prevent the disorderly collapse of AIG during a period 

of extreme financial stress that could have caused significant economic distress for policy holders, municipalities, and small and 

large businesses, and led to even greater financial chaos and a far 

deeper economic slump than the very severe one we have experienced. 
128 

Q.5. Did you or the Board approve of then New York, Fed President Geithner staying on at the New York Fed while working for 

the Obama transition team? If yes, why did you think that was a 

good idea? 

A.5. Timothy Geithner was appointed President of the Federal Reserve Bank of New York for a 5-year term that extended until February 28, 2011. When President Geithner was asked by the President-elect of the United States to serve as Secretary of the Treasury, President Geithner withdrew from the Bank’s day-to-day management pending his confirmation by the Senate. He also relinquished his Federal Open Market Committee (FOMC) responsibilities which were assumed by Christine Cumming, the Reserve 

Bank’s alternate representative elected in accordance with the Federal Reserve Act. President Geithner did not attend the December 

2008 FOMC meeting. Ms. Cumming served as a voting member of 

the FOMC until President Geithner’s successor took office. It was 

expected that President Geithner would continue to serve as President of the Reserve Bank at least through the end of his term if 

he did not become Secretary of the Treasury. 

Q.6. Is the Fed now, or has the Fed in recent years, purchased 

Greek Government or bank debt? 

A.6. The Federal Reserve has not purchased debt of the government of Greece nor has the Federal Reserve purchased the debt of 

any Greek financial institution. Detailed information on the Federal Reserve’s foreign exchange holdings, both currency and investments, is available in the quarterly Treasury and Federal Reserve 

Foreign Exchange Operations report published by the Federal Reserve Bank of New York. See http://www.newyorkfed.org/markets/quarlreports.html. 

Q.7. Unemployment numbers continue to bounce up and down 

every week. As this year goes on, the Census is going to be hiring 

700,000 to 800,000 workers on a temporary basis. Are you worried 

those numbers will distort the true jobs picture, and that economic 

forecasts that use those jobs numbers will be wrong? 

A.7. As you suggest, hiring of temporary workers by the U.S. Bureau of the Census in support of the decennial census will elevate 

the total payroll employment counts reported by the Bureau of 

Labor Statistics (BLS) each month because these temporary workers are included in Federal Government employment in the Current Employment Statistics (CES) survey. However, I do not think 

that Census hiring will make it much more difficult than usual to 

interpret the monthly employment reports. The BLS is publishing 

information each month on the number of temporary census workers in the CES data, and thus it will be straightforward to adjust 

the data to calculate the monthly changes in payroll employment 

excluding the effects of Census hiring; moreover, Census hiring will 

not distort the BLS estimates of employment change in the private 

sector. In addition, the Bureau of the Census has made available 

its hiring plans for coming months, which economic forecasters can 

use in making their projections of employment changes for the remainder of this year. Although these plans are subject to change, 

based on this information, the Department of Commerce expects 

the effect on the level of payroll employment reported by the BLS 
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to peak at about 635,000 jobs in May 2010 and to fall back to 

roughly 25,000 jobs by September. The extent to which Census hiring reduces the measured unemployment rate is more difficult to 

estimate because that effect depends on the prior labor force status 

of the temporary Census workers. However, based on the employment estimates, the peak effect on the unemployment rate in May 

would probably be between 1⁄4 and 1⁄2 percentage point. 

Q.8. Please explain how term deposits and reverse repo transactions are not the economic equivalent of the Fed issuing debt. 

A.8. There are a number of similarities and differences between 

term deposits, reverse repurchase agreements and agency debt obligations. In principle, each could be used to drain reserves from the 

financial system in order to reduce the potential for inflation and 

thereby maintain price stability. Indeed, various central banks use 

instruments similar to these to help manage interest rates and 

maintain price stability. 

In the United States, Congress has specifically authorized the 

Federal Reserve to accept deposits from depository institutions. 

(See 12 USC 342). Congress has also specifically authorized the 

Federal Open Market Committee to direct Reserve Banks to purchase and sell in the open market obligations of, or obligations 

guaranteed as to principal and interest by, the United States or its 

agencies. (See 12 USC 263 and 355). Reverse repurchase agreements represent the sale and purchase of obligations of, or obligations guaranteed as to principal and interest by, the United States 

or its agencies. Congress has not specifically authorized the Federal 

Reserve to issue its own agency debt obligations. 

Unlike deposits and reverse repurchase agreements, agency obligations are freely transferable. Term deposits may only be accepted 

from depository institutions and are not transferable. Reverse repurchase agreements also are not transferable and occur only with 

counterparties that are interested in purchasing qualifying government or agency securities. 

Q.9. Given that you have signaled that the Fed will be using the 

interest on reserves rate as a policy tool in the near future, do you 

believe that rate should be set by the Federal Open Market Committee rather than the Board of Governors? 

A.9. As you know, the Congress has assigned to the Board the responsibility for determining the rate paid on reserves. Although the 

Federal Open Market Committee (FOMC) by law is responsible for 

directing open market operations, the Congress has also assigned 

to the Board the responsibility for determining certain other important terms that are relevant for the conduct of monetary policy— 

for example, the Board ‘‘reviews and determines’’ the discount rates 

that are established by the Federal Reserve Banks; the FOMC has 

no statutory role in setting the discount rate. Similarly, the Board 

sets reserve requirements subject to the constraints established by 

the Congress; the FOMC has no statutory role in setting reserve 

requirements. 

For many years, the Board and the FOMC have worked collegially and cooperatively in setting the discount rate, the Federal 

funds target rate, and other instruments of monetary policy. I am 

convinced that the Board and the FOMC will continue to work co-
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operatively in the future in adjusting all of the instruments of monetary policy.