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S. HRG. 110–854 

FEDERAL RESERVE’S FIRST MONETARY POLICY 

REPORT FOR 2008 

HEARING 

BEFORE THE

COMMITTEE ON 

BANKING, HOUSING, AND URBAN AFFAIRS 

UNITED STATES SENATE 

ONE HUNDRED TENTH CONGRESS 

SECOND SESSION 

ON 

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

FEBRUARY 28, 2008 

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 

THOMAS R. CARPER, Delaware 

ROBERT MENENDEZ, New Jersey 

DANIEL K. AKAKA, Hawaii 

SHERROD BROWN, Ohio 

ROBERT P. CASEY, Pennsylvania 

JON TESTER, Montana 

RICHARD C. SHELBY, Alabama 

ROBERT F. BENNETT, Utah 

WAYNE ALLARD, Colorado 

MICHAEL B. ENZI, Wyoming 

CHUCK HAGEL, Nebraska 

JIM BUNNING, Kentucky 

MIKE CRAPO, Idaho 

ELIZABETH DOLE, North Carolina 

MEL MARTINEZ, Florida 

BOB CORKER, Tennessee 

SHAWN MAHER, Staff Director 

WILLIAM D. DUHNKE, Republican Staff Director and Counsel 

ROGER HOLLINGSWORTH, Deputy Staff Director 

AARON KLEIN, Chief Economist 

DEAN V. SHAHINIAN, Senior Counsel 

JULIE CHON, International Economic Adviser 

MARK OESTERLE, Republican Chief Counsel 

PEGGY KUHN, Republican Senior Financial Economist 

MIKE NIELSEN, Republican Professional Staff Member 

DAWN RATLIFF, Chief Clerk 

DEVIN HARTLEY, Hearing Clerk 

SHELVIN SIMMONS, IT Director 

JIM CROWELL, Editor 

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C O N T E N T S 

THURSDAY, FEBRUARY 28, 2008 

Page 

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

Opening statements, comments, or prepared statements of: 

Senator Shelby .................................................................................................. 4 

Senator Bunning 

Prepared statement ................................................................................... 45 

Senator Dole 

Prepared statement ................................................................................... 45 

WITNESS 

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

System ................................................................................................................... 6 

Prepared statement .......................................................................................... 46 

Response to written questions of: 

Senator Shelby ........................................................................................... 50 

ADDITIONAL MATERIAL SUPPLIED FOR THE RECORD

Monetary Policy Report to the Congress dated February 27, 2008 ..................... 62 

(III)

(1) 

FEDERAL RESERVE’S FIRST MONETARY 

POLICY REPORT FOR 2008 

THURSDAY, FEBRUARY 28, 2008 

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

The Committee met at 10:11 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. 

I am pleased to call the Committee to order this morning. Today, 

the Committee will hear the testimony of Federal Reserve Chairman Ben Bernanke on the outlook of the Nation’s economy, the 

Fed’s conduct of monetary policy, and the status of important consumer protection regulations that are under the Fed’s jurisdiction. 

This is Chairman Bernanke’s second appearance before the Committee this year. Mr. Chairman, it is good to have you with us, 

and, again, it is 2 weeks ago and now again today here. You are 

becoming a regular here, and so we appreciate your appearance before the Committee. 

When Chairman Bernanke was first before the Committee 2 

weeks ago, I laid out the facts of what I consider to be our Nation’s 

very serious, if not perilous, economic condition. Growth is slowing, 

inflation is rising, consumer confidence is plummeting, while indebtedness is deepening. And just as ominously, the credit markets 

have experienced significant disruptions. Consumers are unable or 

unwilling to borrow. Lenders are unable or unwilling to lend. There 

is a palpable sense of uncertainty and even fear in the markets 

with a crisis of confidence that has spread beyond the mortgage 

markets to markets in student loans. And I noted this morning— 

by the way, 2 weeks ago I pointed out that Michigan was indicating 

some serious problems with student lending, and this morning I 

am reading where Pennsylvania today—you may have seen the article—may decide to also curtail student loans as a result of this 

growing economic situation. We have also seen the problem with 

credit cards, government bonds, and corporate finance. 

Unfortunately, the crisis of confidence does not just exist by 

American consumers and lenders. It increasingly appears that 

there is a crisis of confidence among the rest of the world in the 

United States economy. Yesterday, the dollar reached its lowest 

level since 1973, when the dollar was first allowed to float freely. 

And the Fed’s own monetary report details an alarming fact. ForVerDate Nov 24 2008 10:00 Jul 31, 2009 Jkt 048080 PO 00000 Frm 00005 Fmt 6633 Sfmt 6633 S:\DOCS\50369.TXT JASON
2 

eign entities have not only stopped purchasing U.S. securities; they 

have actually been selling them because they have lost, it appears, 

confidence in their value. Now, I am going to be raising some questions, Mr. Chairman, about that, and I will be interested in your 

observations about these reports in the Monetary Policy Report. 

As I have said previously, the catalyst of the current economic 

crisis I believe very strongly is the housing crisis. Overall, 2007 

was the first year since data has been kept that the United States 

had an annual decline in nationwide housing prices. A recent 

Moody’s report forecast that home values will drop in 2008 by 10 

percent to 15 percent, and others are predicting similar declines in 

2009 as well. This would be the first time since the Great Depression that national home prices have dropped in consecutive years. 

We have all witnessed in the past where regionally there have been 

declines in home prices, but to have national numbers like this is 

almost unprecedented, certainly in recent history. 

If the catalyst of the current economic crisis is the housing crisis, 

then the catalyst of the housing crisis is the foreclosure crisis. This 

week, it was reported that foreclosures in January were up 57 percent compared to a year ago and continue to hit record levels. 

When all is said and done, over 2 million Americans could lose 

their homes as a result of what Secretary Paulson has properly and 

accurately described as ‘‘bad lending practices.’’ These are lending 

practices that no sensible banker, I think, would ever engage in. 

Reckless, careless, and sometimes unscrupulous actors in the mortgage lending industry essentially allowed banks—rather, essentially allowed loans to be made that they knew hard-working, lawabiding borrowers would never be able to repay. 

Let me add here very quickly, because I think it is important to 

make the point here, that we are not talking about everyone here 

at all. We are talking about some who engaged in practices that 

I think were unscrupulous or bad lending practices. But many institutions acted very responsibly, and I would not want the world 

to suggest here that this Committee believed that this was an indictment on all lending institutions. And engaged—those who did 

act improperly engaged in practices that the Federal Reserve under 

its prior leadership, in my view, and this administration did absolutely nothing to effectively stop. 

The crisis affects more than families who lose their homes. Property values for each home within a one-eighth square mile of a 

foreclosed home could drop on an average as much as $5,000. This 

will affect somewhere between 44 to 50 million homes in our country. So the ripple effect beyond the foreclosed property goes far beyond that and has a contagion effect, in my view, in our communities all across this country beyond the very stark reality of those 

who actually lose their homes, the effect of others watching the 

value of their properties decline, not to mention what that means 

to local tax bases, supporting local police and fire, and a variety of 

other concerns raised by this issue. 

I certainly want to commend the Fed Chairman—I said so yesterday publicly, Mr. Chairman; I do so again this morning—for 

candidly acknowledging the weakness in the economy and for actively addressing those weaknesses by injecting liquidity and cutting interest rates. I also am pleased that the administration and 

3 

the Congress were able to reach agreement on a stimulus package, 

and our hope is—while some have argued this is not big enough 

or strong enough, our collective hope is this will work, will have 

some very positive impact on the economy. Certainly this will have 

some support, we hope, for working families who are bearing the 

brunt of these very difficult times. 

However, I think more needs to be done to address the root cause 

of our economic problems. Any serious effort to address our economic woes should include, I think, an effort to take on the foreclosure crisis. And, again, there are various ideas out there on how 

we might do this more effectively, and certainly the Chairman and 

others have offered some ideas and suggestions. Senator Shelby 

and I have been working and talking—and Mel Martinez and others who are involved in these issues—about ways in which we can 

in the coming days do constructive things in a positive way to indicate and show not only our concern about the issue but some very 

strong ideas on how we can right this and restore that confidence 

I talked about earlier. 

We on this Committee have already taken some steps to address 

these problems. We have passed the FHA modernization legislation 

through the Committee and the Senate and continue to work to 

make it law. We had a very good meeting yesterday, I would point 

out, Senator Shelby and I and the leadership of the House Financial Services Committee, I say to you, Mr. Chairman, in hopes that 

we can come to some very quick conclusion on that piece of legislation and move it along here. We appropriated close to $200 million to facilitate foreclosure 

prevention efforts by borrowers and lenders, and I want to commend Senator Schumer and others who have been involved in this 

idea of counseling and ideas to minimize the impact of this problem 

as well. 

In addition, the recently enacted stimulus package that I mentioned already includes a temporary increase in the conforming 

loan limits for GSEs to try to address the problems that have 

spread throughout the credit market and the jumbo mortgage market. And while this temporary increase is helpful, we still need to 

implement broad GSE reform. And as I have said previously, I am 

committed to doing that, and we will get that done. 

I have spoken about my belief in the need for additional steps 

to mitigate the foreclosure crisis in a reasonable and thoughtful 

manner. These steps include targeting some community development block grant assistance to communities in a targeted way to 

help them to counter the impact of foreclosed and abandoned properties in their communities. And they include establishing a temporary homeownership loan initiative, which I have raised and others have commented on, either using existing platforms or a new 

entity that can facilitate mortgage refinancing. 

But it is not just the Congress that needs to do more, and, again, 

the Fed needs, in my view, to be as vigilant a financial regulator 

as it has been a monetary policymaker. That includes breaking 

with its past and becoming more vigilant about policing indefensible lending practices. And, again, I commend the Chairman of the 

Federal Reserve—we have talked about this here—on the proposed 

regulations that you have articulated that would follow on the 

4 

HOEPA legislation. And while I have expressed some disappointment about how far they go in certain areas here, the Chairman 

and I have talked about this a bit. We will be involved in the comment period here and are looking forward to finalizing those regulations, and hopefully at least shutting the door on this kind of a 

problem re-emerging in the coming months and years. 

So I want to thank you, Mr. Chairman, and your colleagues and 

urge them to consider some of the stronger measures, and we will 

offer some additional comments on them. 

Despite these unprecedented challenges, I think all of us here on 

this Committee, Republicans and Democrats, remain confident in 

the future of the American economy, and our concerns that will be 

raised here this morning should not reflect anything but that confidence in the future. We may need to change some of our policies, 

regulations, and priorities, but we strongly believe that the ingenuity, productivity, and capability of the American worker and the 

entrepreneur ought never to be underestimated in this country. 

And we remain firm and committed to doing everything we can to 

strengthen those very points. 

So I look forward to working with my good friend, Senator 

Shelby, and other Members of the Committee to do what we can 

here to play our role in all of this in a constructive way, to work 

with you, Mr. Chairman, and the Federal Reserve, the Secretary of 

the Treasury, and others of the financial institution regulators to 

see what we can do in the short term to get this moving in a better 

direction. 

So, with that, let me turn to Senator Shelby for his opening comments, and then we will try to get to some questions. And I will 

leave opening comments for the go-around and question period so 

we can get to a question-and-answer period here to make this as 

productive a session as possible. But we thank you again for being 

with us. 

STATEMENT OF SENATOR RICHARD C. SHELBY 

Senator SHELBY. Thank you, Chairman Dodd. 

Chairman Bernanke, we are pleased to have you again before the 

Committee to deliver the Federal Reserve’s Semiannual Monetary 

Policy Report. I will keep my remarks brief this morning as we are 

all here to hear your views on the U.S. economy and other related 

issues. We also have the benefit of having read about your remarks 

before the House yesterday. 

Chairman Bernanke, the Federal Reserve has taken a number of 

steps over the past 6 months to address the tightening of credit 

markets and the slowdown in economic growth. In a bid to improve 

interbank liquidity, the Federal Reserve established the term auction facility in December of last year and has conducted, as I understand it, six auctions to date. 

Since last August, the Federal Open Market Committee has reduced the Federal funds target a total of 225 basis points, taking 

the target from 5.25 percent to 3 percent. 

Mr. Chairman, since monetary policy works with a lag, the full 

impact of this boost to the economy is not yet clear to you or to us. 

I know that we will spend time this morning discussing the length 

and the depth of the housing correction that Senator Dodd alluded 

5 

to, and I think we should. I also want to make sure, however, that 

this Committee focuses on the risks associated with increasing inflation. 

The Labor Department, Mr. Chairman, reported this week, as 

you know, that wholesale price inflation hit a 26-year high in January. The January rise in the Consumer Price Index meant a 12- 

month change in the overall CPI of 4.3 percent, twice the pace of 

a year ago. In addition, gold and oil are at all-time highs. These 

numbers certainly raise questions, Mr. Chairman, as to how much 

more room the Federal Reserve will have to provide further monetary accommodation without threatening long-term price stability, 

which is very important to all of us. While it is difficult to see our 

Nation’s economy experience minimal growth, the consequences of 

failing to restrain inflation will be far more painful and more difficult to unwind. 

Chairman Bernanke, we are pleased to have you with us this 

morning, and we look forward to your thoughts on this and other 

issues. 

Chairman DODD. Thank you very much. 

Let me correct myself. The tradition has been, Mr. Chairman, if 

Members do want to make some opening comments at a moment 

like this, and I do not want to break that tradition. So I am going 

to ask if any Members would like to make any opening comments 

at this point, I would be happy to entertain them. I realize that has 

been the tradition of the Committee, and I do not want to violate 

the traditions of the Committee. Does any Member want to be 

heard, some opening comments to make at this point? If they 

would like to, I would be happy to entertain—— 

Senator BUNNING. Let me ask a question. If we do not make 

them now and we make them during our timeframe, does that limit 

how many questions we can ask? 

Chairman DODD. Well, that is the idea. I mean, I do not want 

to limit your time, but—— 

[Laughter.] 

Chairman DODD. So if you would like to—— 

Senator SHELBY. Make your opening statement. 

Senator BAYH. That would make Chairman Bernanke happy. 

Chairman DODD. I understand that, and that is why you get the 

gavel after 27 years. But if you would like to make an opening comment—— 

Senator BUNNING. OK. 

Chairman DODD. All right. Anyone else who would like to be 

heard? 

Senator SHELBY. Why don’t you add a minute and do both? 

Chairman DODD. We will add a minute. Why don’t I add a 

minute to the time here? Instead of having 5 or 6 minutes, we will 

make it 7 or 8 minutes. And I have never tried to be too rigid about 

that, and so we will do it that way if that is all right. That will 

move things along. Is that OK with everyone? Thank you very 

much. 

Mr. Chairman, we welcome you to the Committee. 

6 

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 Monetary Policy Report to the Congress. In my testimony this morning, I will briefly review the economic situation and outlook, beginning with developments in real 

activity and inflation, and then turn to monetary policy. 

Senator BUNNING. Mr. Chairman, would you please move that 

microphone a little closer so we can all hear you? 

Mr. BERNANKE. How is this? 

Senator BUNNING. That is good. 

Mr. BERNANKE. I will conclude with a quick update on the Federal Reserve’s recent actions to help protect consumers in their financial dealings. 

The economic situation has become distinctly less favorable since 

the time of our July report. Strains in financial markets, which 

first became evident late last summer, have persisted; and pressures on bank capital and the continued poor functioning of markets for securitized credit have led to tighter credit conditions for 

many households and businesses. The growth of real gross domestic product held up well through the third quarter despite the financial turmoil, but it has since slowed sharply. Labor market conditions have similarly softened, as job creation has slowed and the 

unemployment rate—at 4.9 percent in January—has moved up 

somewhat. 

Many of the challenges now facing our economy stem from the 

continuing contraction of the U.S. housing market. In 2006, after 

a multiyear boom in residential construction and house prices, the 

housing market reversed course. Housing starts and sales of new 

homes are now less than half of their respective peaks, and house 

prices have flattened or declined in many areas. Changes in the 

availability of mortgage credit amplified the swings in the housing 

market. 

During the housing sector’s expansion phase, increasingly lax 

lending standards, particularly in the subprime market, raised the 

effective demand for housing, pushing up prices and stimulating 

construction activity. As the housing market began to turn down, 

however, the slump in subprime mortgage originations, together 

with a more general tightening of credit conditions, has served to 

increase the severity of the downturn. Weaker house prices in turn 

have contributed to the deterioration in the performance of mortgage-related securities and reduced the availability of mortgage 

credit. 

The housing market is expected to continue to weigh on economic 

activity in coming quarters. Home builders, still faced with abnormally high inventories of unsold homes, are likely to cut the pace 

of their building activity further, which will subtract from overall 

growth and reduce employment in residential construction and 

closely related industries. 

Consumer spending continued to increase at a solid pace through 

much of the second half of 2007, despite the problems in the housing market, but it appears to have slowed significantly toward the 

end of the year. The jump in the price of imported energy, which 

7 

eroded real incomes and wages, likely contributed to the slowdown 

in spending, as did the declines in household wealth associated 

with the weakness in house prices and equity prices. 

Slowing job creation is yet another potential drag on household 

spending, as gains in payroll employment averaged little more than 

40,000 per month during the 3 months ending in January, compared with an average increase of almost 100,000 per month over 

the previous 3 months. However, the recently enacted fiscal stimulus package should provide some support for household spending 

during the second half of this year and into next year. 

The business sector has also displayed signs of being affected by 

the difficulties in the housing and credit markets. Reflecting a 

downshift in the growth of final demand and tighter credit conditions for some firms, available indicators suggest that investment 

in equipment and software will be subdued during the first half of 

2008. Likewise, after growing robustly through much of 2007, nonresidential construction is likely to decelerate sharply in coming 

quarters as business activity slows and funding becomes harder to 

obtain, especially for more speculative projects. On a more encouraging note, we see few signs of any serious imbalances in business 

inventories aside from the overhang of unsold homes. And, as a 

whole, the nonfinancial business sector remains in good financial 

condition, with strong profits, liquid balance sheets, and corporate 

leverage near historical lows. 

In addition, the vigor of the global economy has offset some of 

the weakening of domestic demand. U.S. real exports of goods and 

services increased at an annual rate of about 11 percent in the second half of last year, boosted by continuing economic growth 

abroad and the lower foreign exchange value of the dollar. 

Strengthening exports, together with moderating imports, have in 

turn led to some improvement in the U.S. current account deficit, 

which likely narrowed in 2007—on an annual basis—for the first 

time since 2001. Although recent indicators point to some slowing 

of foreign economic growth, U.S. exports should continue to expand 

at a healthy pace in coming quarters, providing some impetus to 

domestic economic activity and employment. 

As I have mentioned, financial markets continue to be under considerable stress. Heightened investor concerns about the credit 

quality of mortgages, especially subprime mortgages with adjustable interest rates, triggered the financial turmoil. However, other 

factors, including a broader retrenchment in the willingness of investors to bear risk, difficulties in valuing complex or illiquid financial products, uncertainties about the exposures of major financial 

institutions to credit losses, and concerns about the weaker outlook 

for economic growth, have also roiled the financial markets in recent months. To help relieve the pressures in the market for interbank lending, the Federal Reserve—among other actions—recently 

introduced a term auction facility, through which prespecified 

amounts of discount window credit are auctioned to eligible borrowers, and we have been working with other central banks to address market strains that could hamper the achievement of our 

broader economic objectives. These efforts appear to have contributed to some improvement in short-term funding markets. We will 

continue to monitor financial developments closely. 

8 

As part of its ongoing commitment to improving the accountability and public understanding of monetary policymaking, the 

Federal Open Market Committee—or FOMC—recently increased 

the frequency and expanded the content of the economic projections 

made by Federal Reserve Board members and Reserve Bank presidents and released to the public. The latest economic projections, 

which were submitted in conjunction with the FOMC meeting at 

the end of January and which are based on each participant’s assessment of appropriate monetary policy, show that real GDP was 

expected to grow only sluggishly in the next few quarters and that 

the unemployment rate was likely to increase somewhat. In particular, the central tendency of the projections was for real GDP to 

grow between 1.3 percent and 2.0 percent in 2008, down from 21⁄2

percent to 23⁄4 percent projected in our report last July. FOMC participants’ projections for the unemployment rate in the fourth quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent, 

up from the level of about 43⁄4 percent projected last July for the 

same period. The downgrade in our projections for economic activity in 2008 since our report last July reflects the effects of the financial turmoil on real activity and a housing contraction that has 

been more severe than previously expected. By 2010, our most recent projections show output growth picking up to rates close to or 

a little above its longer-term trend and the unemployment rate 

edging lower; the improvement reflects the effects of policy stimulus and an anticipated moderation of the contraction in housing 

and the strains in financial and credit markets. The incoming information since our January meeting continues to suggest sluggish 

economic activity in the near term. 

The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or the labor market 

may deteriorate more than is currently anticipated and that credit 

conditions may tighten substantially further. 

Consumer price inflation has increased since our previous report, 

in substantial part because of the steep run-up in the price of oil. 

Last year, food prices also increased significantly, and the dollar 

depreciated. Reflecting these influences, the price index for personal consumption expenditures—or PCE—increased 3.4 percent 

over the four quarters of 2007, up from 1.9 percent in 2006. Core 

price inflation—that is, inflation excluding food and energy prices— 

also firmed toward the end of the year. The higher recent readings 

likely reflected some pass-through of energy costs to the prices of 

core consumer goods and services as well as the effect of the depreciation of the dollar on import prices. Moreover, core inflation in 

the first half of 2007 was damped by a number of transitory factors—notably, unusually soft prices for apparel and for financial 

services—which subsequently reversed. For the year as a whole, 

however, core PCE prices increased 2.1 percent, down slightly from 

2006. 

The projections recently submitted by FOMC participants indicate that overall PCE inflation was expected to moderate significantly in 2008, to between 2.1 percent and 2.4 percent—the central 

tendency of the projections. A key assumption underlying those 

projections was that energy and food prices would begin to flatten 

out, as implied by quotes on futures markets. In addition, diminVerDate Nov 24 2008 10:00 Jul 31, 2009 Jkt 048080 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 S:\DOCS\50369.TXT JASON
9 

ishing pressure on resources is also consistent with the projected 

slowing in inflation. The central tendency of the projections for core 

PCE inflation in 2008, at 2.0 percent to 2.2 percent, was a bit higher than in our July report, largely because of some higher-than-expected recent readings on prices. Beyond 2008, both overall and 

core inflation were projected to edge lower, as participants expected 

inflation expectations to remain reasonably well anchored and 

pressures on resource utilization to be muted. The inflation projections submitted by FOMC participants for 2010—which ranged 

from 1.5 percent to 2.0 percent for overall PCE inflation—were importantly influenced by participants’ judgments about the measured rates of inflation consistent with the Federal Reserve’s dual 

mandate and about the timeframe over which policy should aim to 

achieve those rates. 

The rate of inflation that is actually realized will, of course, depend on a variety of factors. Inflation could be lower than we anticipate if slower-than-expected global growth moderates the pressure on the prices of energy and other commodities or if rates of 

domestic resource utilization fall more than we currently expect. 

Upside risks to the inflation projection are also present, however, 

including the possibilities that energy and food prices do not flatten 

out or that the pass-through to core prices from higher commodity 

prices and from the weaker dollar may be greater than we anticipate. Indeed, the further increases in the prices of energy and 

other commodities in recent weeks, together with the latest data on 

consumer prices, suggest slightly greater upside risks to the projections of both overall and core inflation than we saw last month. 

Should high rates of overall inflation persist, the possibility also exists that inflation expectations could become less well anchored. 

Any tendency of inflation expectations to become unmoored or for 

the Fed’s inflation-fighting credibility to be eroded could greatly 

complicate the task of sustaining price stability and could reduce 

the flexibility of the FOMC to counter shortfalls in growth in the 

future. Accordingly, in the months ahead, the Federal Reserve will 

continue to monitor closely inflation and inflation expectations. 

Let me turn now to the implications of these developments for 

monetary policy. The FOMC has responded aggressively to the 

weaker outlook for economic activity, having reduced its target for 

the Federal funds rate by 225 basis points since last summer. As 

the Committee noted in its most recent post-meeting statement, 

the intent of those actions has been to help promote moderate 

growth over time and to mitigate the risks to economic activity. 

A critical task for the Federal Reserve over the course of this 

year will be to assess whether the stance of monetary policy is 

properly calibrated to foster our mandated objectives of maximum 

employment and price stability in an environment of downside 

risks to growth, stressed financial conditions, and inflation pressures. In particular, the FOMC will need to judge whether the policy actions taken thus far are having their intended effects. Monetary policy works with a lag. Therefore, our policy stance must be 

determined in light of the medium-term forecast for real activity 

and inflation as well as by the risks to that forecast. Although the 

FOMC participants’ economic projections envision an improving 

economic picture, it is important to recognize that downside risks 

10 

to growth remain. The FOMC will be carefully evaluating incoming 

information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against downside risks. 

Finally, I would like to say a few words about the Federal Reserve’s recent actions to protect consumers in their financial transactions. In December, following up on a commitment I made at the 

time of our report last July, the Board issued for public comment 

a comprehensive set of new regulations to prohibit unfair or deceptive practices in the mortgage market, under the authority granted 

us by the Home Ownership and Equity Protection Act of 1994. The 

proposed rules would apply to all mortgage lenders and would establish lending standards to help ensure that consumers who seek 

mortgage credit receive loans whose terms are clearly disclosed and 

that can reasonably be expected to be repaid. Accordingly, the rules 

would prohibit lenders from engaging in a pattern or practice of 

making higher-priced mortgage loans without due regard to consumers’ ability to make the scheduled payments. In each case, a 

lender making a higher-priced loan would have to use third-party 

documents to verify the income relied on to make the credit decision. For higher-priced loans, the proposed rules would require the 

lender to establish an escrow account for the payment of property 

taxes and homeowners’ insurance and would prevent the use of 

prepayment penalties in circumstances where they might trap borrowers in unaffordable loans. In addition, for all mortgage loans, 

our proposal addresses misleading and deceptive advertising practices, requires borrowers and brokers to agree in advance on the 

maximum fee that the broker may receive, bans certain practices 

by servicers that harm borrowers, and prohibits coercion of appraisers by lenders. We expect substantial public comment on our 

proposal, and we will carefully consider all information and viewpoints while moving expeditiously to adopt final rules. 

The effectiveness of the new regulations, however, will depend 

critically on strong enforcement. To that end, in conjunction with 

other Federal and State agencies, we are conducting compliance reviews of a range of mortgage lenders, including nondepository lenders. The agencies will collaborate in determining the lessons 

learned and in seeking ways to better cooperate in ensuring effective and consistent examinations of, and improved enforcement for, 

all categories of mortgage lenders. 

The Federal Reserve continues to work with financial institutions, public officials, and community groups around the country to 

help homeowners avoid foreclosures. We have called on mortgage 

lenders and servicers to pursue prudent loan workouts and have 

supported the development of a streamlined, systematic approach 

to expedite the loan modification process. We also have been providing community groups, counseling agencies, regulators, and others with detailed analyses to help identify neighborhoods at high 

risk from foreclosures so that local outreach efforts to help troubled 

borrowers can be as focused and effective as possible. We are actively pursuing other ways to leverage the Federal Reserve’s analytical resources, regional presence, and community connections to 

address this critical issue. 

11 

In addition to our consumer protection efforts in the mortgage 

area, we are working toward finalizing rules under the Truth in 

Lending Act that will require new, more informative, and consumer-tested disclosures by credit card issuers. Separately, we are 

actively reviewing potentially unfair and deceptive practices by 

issuers of credit cards. Using the Board’s authority under the Federal Trade Commission Act, we expect to issue proposed rules regarding these practices this spring. 

Thank you. I would be pleased to take your questions. 

Chairman DODD. Thank you very much, Mr. Chairman. 

We will make these 7 to 8 minutes, and, again, I will not be rigid 

about the time constraints. 

Let me begin, Mr. Chairman, by going back to that old question 

that was asked more than, I guess, 30 years ago. I will sort of paraphrase on it, and that is, are we better off today to respond to this 

situation than we were—in this case I want to ask 7 years ago. The 

question that Ronald Reagan asked, I think, in 1980 in that campaign, Are we better off today than we were yesterday? And the 

reason I raise that is because I have been struck by the similarities 

between 2001 and that period going into, potentially falling into a 

recession, and here we are in 2008. 

The parallel seems striking to me in some ways, and I want you 

to comment on this, if you could. At both moments in this 7-year 

period, we are on the brink of a recession—at least it seems so. The 

Fed was cutting interest rates very aggressively. A major asset 

bubble—in this case, it was the high-tech community rather than 

housing—was bursting. Yet despite those similarities, the differences in the basic economic information seems to be very, very 

different as well. Americans had just experienced the greatest economic boom in a generation. Real wages had gone up substantially. 

Income inequality had narrowed. The Federal Government was in 

a surplus. In fact, on this very Committee, your predecessor came 

to a hearing—I do not know who else was on the Committee in 

those days, but he came and talked about the things we ought to 

think about by retiring the national debt entirely. There were some 

downsides to that, and we actually had a very good hearing with 

Alan Greenspan about that very question in 2001. The dollar was 

at record highs as well, and, of course, today we are in the opposite 

position, with the dollar at its lowest level since we began floating 

currencies in 1973. Inflation is at a 17-year high. Real wages are 

falling, and we are faced with record Government debt and deficits. 

A very different fact situation than was the case in 2001. 

In 2001, as well, one might argue that there were deliberate actions taken by the Federal Reserve to deal with rising inflation. So 

the steps were in response to inflation here. Obviously, what is provoking, I think, the action—and you can certainly comment on 

this—is a different fact situation. 

So the question appears in a sense: Are we in a—what would be 

your analysis? Are we in a—comparing these two periods in time 

of history, relatively close to each other, faced with similar situations, it would appear to me that we are not in as strong a position 

to respond to this as we were in 2001. And so the question is, Are 

we better off? And if so, I would like you to explain why. And if 

not, what should we be doing and what different steps should we 

12 

be taking if we cannot rely on these basic underlying strengths 

that occurred in 2001 that helped us at that time as opposed to 

where we are today? 

Mr. BERNANKE. Mr. Chairman, there are certainly some similarities with the 2001 experience, most obviously the sharp change in 

asset price. In the previous case, it was the stock market, the tech 

stocks; in this case, it is home prices. But there are some important 

differences as well, as you point out. The decline in home prices is 

creating a much broader set of issues, both for borrowers and 

homeowners, but also for the credit markets. And so we have a sustained disruption in the credit process which has gone on now since 

last August and is not yet near completion. That is a continuing 

drag on the economy and a continuing problem for us as we try to 

restore stronger growth. 

The other problem is that we do have greater inflation pressure 

at this point than we did in 2001, and that is coming from oil. In 

2001, the price of oil was somewhere around $20. Today it is $100. 

Chairman DODD. Right. 

Mr. BERNANKE. The increase in commodity prices around the 

world as the global economy expands and increases demand for 

those commodities is creating an inflationary stress which is complicating the Federal Reserve’s attempts to respond. 

In some other ways, things are different. You pointed out the dollar was very strong in 2001. That was in part reflective of a large 

trade deficit at that time. It has since depreciated. But, on the 

other hand, part of the effect of that depreciation has been that we 

are at least seeing some improvement in that trade deficit, which 

is a positive factor. 

On the fiscal situation, I agree we are in a less advantageous situation than we were. The deficit is certainly higher, and perhaps 

even more seriously, we are now 7 years further on toward the retirement of the baby boomers and the entitlements, and those costs 

that are certainly bearing down on us as we speak. 

So it is a difficult situation, and there are multiple factors. I 

think there are some similarities, but as a Russian novelist once 

said, ‘‘Unhappy families are all unhappy in their own way,’’ and 

every period of financial and economic stress has unique characteristics. 

Chairman DODD. Well, do you have any recommendations, then, 

differently here? If we are responding in a very similar way with 

different underlying economic fact situations, are there other 

things we ought to be doing here, taking any kind of a different approach? Or are we secure in feeling that the present course of action being taken by the Fed and by the administration is going to 

produce the desired results? That period of recession lasted about 

8 months. There are fears that this one, if it takes hold, could be 

far more long-lasting for the very reasons we have outlined in the 

underlying problems economically that exist. 

Mr. BERNANKE. Well, to some extent, the private sector is going 

to have to work through the problems in the financial markets. 

That is something that they will have to do with the help and guidance of the regulators and the supervisors, which we are certainly 

doing. We are reviewing our practices and our policies and trying 

to see how we can improve them. 

13 

With respect to the broader economy, of course, we have both 

monetary and fiscal policy action now underway, which I hope will, 

and we project will, lead to stronger growth in the second half of 

this year. An important issue, as you have already alluded to, is 

the effects of the home price declines on consumers and, in particular, the delinquencies and foreclosures which we are now seeing. 

I have described briefly in my remarks some of the things that 

we have done in calling on private servicers and lenders to scale 

up their activities, to use more streamlined processes. I think it is 

important for us and for the servicers to move beyond temporary 

palliatives that they are using in many cases with delinquent borrowers and try to find more permanent, sustainable solutions in 

terms of restructuring mortgages or refinancing into the FHA or 

other mechanisms. 

Congress has already taken some steps, as you mentioned, and 

would urge you to continue to work on FHA modernization and 

GSE reform. 

Chairman DODD. Right. 

Mr. BERNANKE. Those are two areas that can help us meet these 

challenges. 

Additional steps may be necessary in the future, but at this 

point, I think we have taken a number of useful steps. We need 

to keep thinking about possible future options, but I do not have 

any additional recommendations right now. 

Chairman DODD. I do not want to put words in your mouth, obviously, at all here, but I am looking at—obviously the housing burst 

or bubble, the burst of that bubble is, I think, far more dangerous 

than a high-tech problem, as you make those comparisons. Inflation and trade deficits are worse. Am I hearing you correctly that 

we are actually in a worse position today to respond to this than 

we were 8 years ago? Is that how I hear what you are saying? 

Mr. BERNANKE. I think that is fair in that both fiscal and monetary policy face some additional constraints. Many people owned 

stocks, too, of course, and so that affected their wealth and their 

willingness to spend. But, in fact, the effects of the stock market 

declines in 2001 were primarily on investment firms than on consumers. In this case, the consumers are taking the brunt of the effects. 

Chairman DODD. That is a good additional point. I did not make 

that. 

Senator Shelby. 

Senator SHELBY. Thank you, Mr. Chairman. 

Chairman Bernanke, as I noted earlier, wholesale prices rose by 

1 percent in January and 7.4 percent over the past year. This is 

the fastest increase in 26 years. In your opening statement, you 

noted greater upside risks to both overall and core inflation than 

we saw previously. Additionally, the most recent minutes of the 

Federal Open Market Committee gave anecdotal evidence that in 

some instances these price increases were passed on to consumers. 

The FOMC also noted a risk that inflation expectations could become less anchored. 

14 

Do you have any concern at all that the 225 basis-point cut to 

the Federal funds rate has limited the options that can be used to 

combat the upside risk of inflation? 

Mr. BERNANKE. Well, Senator, to answer that question, the PPI, 

the Producer Price Index, that you referred to mostly reflects the 

effects of large increases in prices of energy and other commodities. 

We live in a world where energy and metals and other commodities 

are globally traded, food as well, and demand of emerging market 

economies and a growing global economy has put pressure on the 

available supplies of those resources and has driven up those 

prices. And as I mentioned, the price of oil has quintupled or more. 

Senator SHELBY. Do you see that abating? 

Mr. BERNANKE. In 2007, the price of oil rose by about two-thirds, 

and I suspect—and the futures markets agree—that it is much 

more likely that oil prices, while remaining high, will not increase 

by anything like that amount going forward. If oil prices and food 

prices do stabilize to some extent, even if they do not fall, that will 

be sufficient to bring inflation down as we have projected. 

Now, you are correct, though, that we do have to be very cautious. While we cannot do much about oil prices or food prices in 

the short run, we do have to be careful to make sure that those 

prices do not either feed substantially into other types of prices, 

other goods and services produced domestically, and that they do 

not dislodge inflation expectations or make the public less confident 

that the Federal Reserve will, in fact, control inflation, as we will. 

So we do have to watch those things very carefully, and will 

watch them very carefully. 

Senator SHELBY. Is that what some of us would talk about, the 

psychology of inflation? 

Mr. BERNANKE. Well, that is another way to put it. But, yes, inflation expectations essentially are measured many different ways, 

and I think the evidence is that they remain pretty stable. If you 

look at forecasters’ long-term inflation expectations, consumer surveys, and even the financial markets, they show that inflation expectations remain reasonably well anchored. But it is certainly 

something we have to watch very carefully. 

Senator SHELBY. Do you believe that setting a Fed funds rate 

target lower than the inflation rate—that is, a negative real rate 

of interest—can be an appropriate response to an economic slowdown? In other words, how long can the Fed run a negative real 

rate before inflationary pressures grow to dangerous levels? 

Mr. BERNANKE. Well, Senator, there are different ways to measure the real interest rate. The one that is relevant is the one that 

is looking forward, and, again, if oil prices do not continue to rise 

at this pace they have, I think we would still be on the positive 

side of the real interest rate. 

Now, in the past, the Fed has for short periods lowered the rate 

to a negative level, but as you point out, that is not something you 

want to do for a sustained period. 

Senator SHELBY. The Fed cannot ignore price stability, can it, 

when you are making these decisions to have more liquidity in the 

financial market? 

Mr. BERNANKE. Senator, we are facing a situation where we have 

simultaneously a slowdown in the economy, stress in the financial 

15 

markets, and inflation pressure coming from these commodity 

prices abroad. And each of those things represents a challenge. We 

have to make our policy in trying to balance those different risks 

in a way that will get the best possible outcome for the American 

economy. 

Senator SHELBY. Would you be trying to avoid stagflation, as 

some people call it? 

Mr. BERNANKE. I do not anticipate stagflation. I do not think we 

are anywhere near the situation that prevailed in the 1970’s. I do 

expect inflation to come down. If it does not, we will have to react 

to it, but I do expect that inflation will come down and that we will 

have both return to growth and price stability as we move forward. 

Senator SHELBY. Do you still believe that the fundamentals of 

our economy is still robust, is strong, other than the housing market and some of the financial challenges that we have coming out 

of that? 

Mr. BERNANKE. Senator, I realize my testimony was not the most 

cheerful thing you will hear today, and I was thinking very much 

about the short-term challenges that we face in terms of the financial markets and growth and inflation. But I do very much believe 

that the U.S. economy will return to a strong growth path with 

price stability. We have enormous resources, resilience, productivity, and I am quite confident in the American economy and the 

American people that we will have strong economic growth in the 

next few years. 

Senator SHELBY. Mr. Chairman, a commonly watched measure of 

inflation, as you well know, is the core CPI. Housing constitutes, 

I understand, almost a third of the core CPI. To what extent has 

the recent decline in housing prices moderated recent increases in 

the core CPI? As housing prices go down, inflation, you know, 

should play here in a negative way, should it not? 

Mr. BERNANKE. Well, Senator, not necessarily. You can get actually a perverse effect, which is that as house prices—— 

Senator SHELBY. And how would that work? 

Mr. BERNANKE. As house prices fall, people will become more reluctant to buy a house because they are afraid that the house price 

will keep falling, so they rent instead. And that puts pressure on 

rents and actually could drive up the rent. 

Senator SHELBY. Good for the landlords and bad for the sellers. 

Mr. BERNANKE. It can be, and the way the Bureau of Labor Statistics calculates the cost of homeownership, it uses a lot of information from measured rents. So you can actually get—as we did 

last year—a period where the cost of homeownership as measured 

by the BLS actually went up, even though house prices were coming down, because of the fact that people were renting more and 

rental costs were going up. That effect has moderated somewhat recently, and that has helped to keep down—— 

Senator SHELBY. What would be the trend from your perspective 

in the core CPI if house prices were excluded? 

Mr. BERNANKE. House prices are not included—— 

Senator SHELBY. I know they are not, but what if you did exclude 

them? What would be the trend in the core CPI? 

Mr. BERNANKE. I am sorry. House prices are not included in 

the—— 

16 

Senator SHELBY. OK, they are not. 

Mr. BERNANKE. In the CPI. What is included—— 

Senator SHELBY. They are excluded. 

Mr. BERNANKE. The measure of shelter costs is related to rents 

drawn from various sources. 

Senator SHELBY. One more question, Mr. Chairman. 

What do you judge to be the threat of slow growth continuing 

with inflation remaining above the Federal Reserve’s comfort level? 

What would you say to that? In other words, what do you judge to 

be the threat of the slow growth continuing with inflation remaining above your comfort level? 

Mr. BERNANKE. Well, we are certainly aiming to achieve our 

mandate, which is maximum employment and price stability. We 

project that that will be happening. We are watching very carefully 

because there are risks to those projections. One of the risks, obviously, is the performance of the financial markets, and that again, 

as I mentioned before, complicates the situation. 

As events unfold—and certainly there are many things that we 

cannot control or cannot anticipate at this point—we are simply 

going to have to keep weighing the different risks and trying to 

find an appropriate balance for policy going forward. 

Senator SHELBY. As a bank regulator, too—this will be my last 

question, Mr. Chairman—do you fear some bank failures in this 

country? I know there are big risks where they are heavily involved 

in real estate lending. Does that bother you as a bank regulator? 

Mr. BERNANKE. Well, I believe the FDIC and the OCC have recently provided some information. There probably will be some 

bank failures. There are, for example, some small or in many cases 

de novo banks that are heavily invested in real estate in locales 

where prices have fallen, and, therefore, they would be under some 

pressure. So I expect there will be some failures. 

Among the largest banks, the capital ratios remain good, and I 

do not anticipate any serious problems of that sort among the large 

internationally active banks that make up a very substantial part 

of our banking system. 

Senator SHELBY. Do you see some of those larger banks seeking 

additional capital to bolster themselves? 

Mr. BERNANKE. They have already sought something on the order of $75 billion in capital in the last quarter. 

Senator SHELBY. Is that enough? 

Mr. BERNANKE. I would like to see them get more. They have 

enough now certainly to remain solvent and to remain above, well 

above their minimum capital levels. But I am concerned that banks 

will be pulling back and not making new loans and providing the 

credit, which is the lifeblood of the economy. In order to be able to 

do that, they need in many cases—not all cases, but in some cases 

at least—they need to get more capital. 

Senator SHELBY. Thank you. 

Chairman DODD. Thank you very much, Mr. Chairman. 

Let me just say to the Chairman, I said this to him privately, but 

I really appreciate your candor in all of this. Your job is not to be 

a cheerleader but to lay out for us exactly how you see things. And 

I for one, anyway—I do not know if other Members feel likewise, 

but I am very appreciative of the fact that you are very clear and 

17 

very straightforward on your assessment of these matters, and that 

is important. 

Senator Reed. 

Senator REED. Well, thank you very much, Mr. Chairman. And, 

Chairman Bernanke, welcome. I will say first that you bring to this 

very challenging job great intellect and great integrity, and I appreciate it very much. And it is a daunting moment in our economic history. 

You said in rather unemotional terms, characteristically talked 

about the squeeze that families are feeling. What I have heard in 

Rhode Island is exactly the same thing: increased costs for practically everything you need, flat wages, and then the housing problem taking away that sense of well reserve if something goes 

wrong. 

In fact, I was particularly struck by comments that were related 

to me about the bakers in Rhode Island, the family bakeries who 

have seen the price of wheat go up 200, 300, 400 percent. It is unprecedented, frankly. And if that continues, we are going to have 

real serious, serious problems, as you alluded to. 

The Fed has two major responsibilities: monetary policy but regulation of large financial institutions. And in that latter category, 

I alluded to this in our last conversation in the Committee about 

your take on, frankly, how well you have activated your regulatory 

responsibilities in these last few years. 

We have seen major institutions write off billions of dollars, and 

mostly because of off-balance-sheet transactions. And it is quite 

clear that the Fed is there on a daily basis in all the institutions. 

I think the former Chairman of the CEA, Martin Feldstein, wrote, 

‘‘The Fed’s banking examiners have complete access to all the financial transactions of the banks that they supervise and should 

have the technical expertise to evaluate the risks that those banks 

are taking.’’ 

Well, it seems quite clear now, with the restatement of balance 

sheets that these banks are taking lots of risks that they did not 

really see as risks. 

Are you satisfied that you have in place the regulatory procedures? And are you—I do not know what the right word is—disappointed that your regulatory apparatus did not alert the banks 

or monitor the banks more closely over the last several months? 

Mr. BERNANKE. Well, Senator, you raise some important questions. First of all, we and our fellow regulators, both in the United 

States and around the world, are engaged, as you might imagine, 

in a very serious review of what has happened and what we can 

do better in the future. The Federal Reserve itself is looking at our 

own practices and staffing and all those issues. The President’s 

Working Group is working on a set of recommendations looking 

broadly at the financial markets and the problems that arose. And 

all of those discussions and information will be feeding into an 

international analysis—the Financial Stability Forum, the Basel 

Committee, international groups of financial regulators, central 

banks, Finance Ministers, and so on—which will try to determine, 

what the problems were, where we can do better, and what we 

have learned from this episode. So we are certainly doing a lot of 

stock taking and trying to determine where there were problems. 

18 

In terms of the banks it should be emphasized that we do work 

very closely with the other regulators—the OCC, the FDIC, and 

others, depending on the type of bank. Our focus, I think of necessity, is for the most part on things such as the overall structure 

of risk management, the practices and procedures that the banks 

follow. 

It is very difficult for us to second-guess the specific asset price 

or asset purchase decisions that they make. I think going forward 

we do need to look in a much tougher way at the risk management 

and risk measurement procedures that the banks have. But, again, 

it is very difficult for us to tell a bank that—when they make a certain investment that they think it is a good investment, and they 

have done all the due diligence—that it is a bad investment. That 

is not usually our role. 

Senator REED. Let me follow up with two questions and ask for 

a brief response. First, when do you anticipate sharing with this 

Committee the results of this analysis you are doing of your regulatory position within the next several months in a detailed basis? 

Mr. BERNANKE. Well, the President’s Working Group and then 

the international bodies—the Financial Stability Forum, the Basel 

Committee—are anticipating sharing these reports within the next 

couple of months. The Financial Stability Forum has already 

issued a preliminary interim report trying to identify the areas of 

weakness and problems. 

Senator REED. Another question, and this goes back to sort of the 

level of detail. Do your examiners look at what is happening on the 

trading desks of these large institutions in real time and then compare it to what is happening on the asset side? I mean, there has 

been a suggestion in some institutions that while they were being 

booked, some of these investments, at a reasonably high price, the 

traders were selling at a deep discount. Is that something that you 

did or propose to do in the future? 

Mr. BERNANKE. Well, again, we cannot look over the shoulder of 

every trader on every trade, but what we can try to do is ensure 

that the systems exist so that the bank is ensuring that the appropriate markdowns are taking place so that they are consistent between the trade and the booking. So we do look at the systems and 

the risk management systems to try to determine if they are properly managed. 

Senator REED. Well, you know, I think we have a problem here, 

frankly, maybe because—and, again, you can take a systematic 

procedure, see that the procedures are all in place, but if the procedures are missing a major point or the assumptions underlying the 

procedures are outdated—and I would hope that your review would 

be prompt and timely and allow us to see details of what you have 

been looking at. 

Let me ask a question. You brought up Basel II. One of the aspects of Basel II, to my understanding, is a reliance on ratings and 

rating agencies. In fact, it has been reported that Northern Rock, 

the British institution that failed that has now been nationalized 

by the British Government, was able to lower their risk-weighted 

assets by 44 percent under Basel II. The CEO at the time described 

it as the ‘‘benefits of Basel.’’ I suspect he is not describing it as 

19 

that—certainly the Prime Minister is not describing it as the ‘‘benefits of Basel’’ now. 

Does that give you pause with respect to rushing forward with 

Basel II? 

Mr. BERNANKE. Well, Basel II, I still believe, is the right direction. It is based on properly measuring risk and relating capital to 

the amount of risk that you are taking. I think in the case of 

Northern Rock, the real, most serious problems were not in the 

asset quality but, in fact, were due to a lack of liquidity planning 

because they did not have sources of liquidity when the run occurred, essentially. And we in our implementation of Basel II here 

in the United States do make liquidity planning an important part 

of our analysis. 

You mentioned credit ratings. It is true that credit ratings do 

play a role in some of the Basel II risk evaluations. They do not 

play a unique role. It is generally the case that banks are expected 

to make independent evaluations along with taking information 

from the credit ratings. However, this is certainly one of the areas 

where the Basel Committee, in reviewing the lessons of the recent 

events, is looking carefully on how or whether to use credit ratings 

in the risk measurement process. 

Senator REED. Thank you, Mr. Chairman. 

Thank you, Chairman Dodd. 

Chairman DODD. Yes, excellent questions. And, Mr. Chairman, 

just picking up on Jack Reed’s questions here, it may be worth— 

I had not thought about the Basel implications. We have looked at 

this thing, obviously, in a more parochial way, but I might ask the 

Chairman of the Fed to give us—we had one hearing on this. Senator Shelby cares deeply about this issue, as I do as well, the rating agencies. It is a complicated issue. But I think all of us would 

be deeply appreciative of some ideas from the Fed to us. If there 

is any need here for legislative action at all in this area, we would 

be very interested in hearing your thoughts and ideas on that as 

well. 

Mr. BERNANKE. Senator, the Basel Accord is implemented by regulation, and we have determined a joint action by the four bank 

regulators. We are working together through regulation to try to 

make improvements. We will certainly take a lot of advice from the 

Basel Committee and the changes and suggestions that they make. 

We have a very conservative process in place for introducing the 

Basel II system, which includes several years of transition floors 

that will not allow capital to decline very much, and a lookback 

study that will review the experience both here in the United 

States and elsewhere to try to understand and make sure that we 

are confident that the system is going to develop appropriately and 

provide enough capital for banks. 

So we will be taking the lessons of the recent experience very 

much to heart and incorporating them in the system. Basel II has 

the virtue of being flexible enough that it can adjust when you 

make changes like this. So I do not think at this point that legislation is necessary. 

Chairman DODD. OK. Well, I am pleased to hear that, and as I 

said, it is an excellent question that Senator Reed has asked. 

Senator Bennett. 

20 

Senator BENNETT. Thank you very much, Mr. Chairman, and 

welcome, Chairman Bernanke. I trust you saw the piece in this 

morning’s Wall Street Journal, the op-ed piece by Allan Meltzer. 

Mr. BERNANKE. Yes. 

Senator BENNETT. ‘‘That 1970’s Show.’’ I will give you an opportunity to comment on that. 

Mr. BERNANKE. Well, Mr. Meltzer, who is an excellent economist 

and indeed who is a historian of the Federal Reserve, is concerned 

that the current situation will begin to look like the 1970s, with 

very high inflation and high unemployment. I would dispute his 

analysis on the grounds that I do believe that monetary policy has 

to be forward looking, has to be based on where we think the economy and the inflation rate are heading. And as I said, the current 

inflation is due primarily to commodity prices—oil and energy and 

other prices—that are being set in global markets. I believe that 

those prices are likely to stabilize, or at least not to continue to rise 

at the pace that we have seen recently. If that is the case, then inflation should come down, and we should have, therefore, the ability to respond to what is both a slowdown in growth and a significant problem in the financial markets. 

He is correct, however, that there is some risk, and if the inflation expectations look to be coming unmoored, or if the prices of energy and commodities begin to feed into other costs of goods and 

services, we would have to take that very seriously. I mentioned 

that core inflation last year was 2.1 percent, so it is food prices and 

energy prices, which are internationally traded commodities, which 

are the bulk of the inflation problem. 

Again, we do have to watch it very carefully, but I do not think 

we are anywhere near the 1970s type situation. 

Senator BENNETT. Thank you. I wanted to get that on the record. 

As I look at the housing market and talk to some of my friends 

who are in the housing market, they tell me that the inventory is 

not monolithic, the inventory overhang—that is that the bulk of the 

overhang is in the higher-priced homes, because home builders 

wanted to build places where they would get the highest margin 

return, and if they built houses in the moderate housing area or 

affordable housing, their margins were not nearly as great and 

there were plenty of speculators willing to buy the bigger homes. 

And, indeed, they tell me that for affordable housing, there is, 

frankly, not a sufficient supply right now. 

They are urging me to do something on fiscal policy to stimulate 

people to build cheaper houses, that the housing construction 

would begin to catch up—not catch up. Construction levels would 

begin to pick up, whereas now they are dormant, waiting for the 

overhang to be worked off. 

Do you have any data that supports that anecdotal report? 

Mr. BERNANKE. Well, we do have some data on investor-owned 

properties, and that has been increasing quite a bit. And my recollection is that among the mortgages that are having problems, 

something on the order of 20 percent of them are investor-owned; 

therefore, it is not a family that is being in risk of losing their 

home. So that is a significant consideration, and I think that in 

those cases investors who make a bad investment should bear the 

consequences. 

21 

Senator BENNETT. That is my own attitude as well. But we are 

having conversations about stimulus packages around here, and it 

had not occurred to me, until I had this information from people 

in the housing market, that if we could stimulate people to buy the 

lower-priced houses, and those are the people who need the shelter, 

anyway, and there is not a surplus of inventory there, that that 

would have a very salutary effect both in terms of taking care of 

people’s needs and on the economy, because home builders would 

start to build again, they just would not be building in that portion 

of the housing market where there is an oversupply. But you do 

not have any specific data as to where the price points are in the 

inventory overhang? 

Mr. BERNANKE. I could probably obtain such data. I am not sure 

that directly trying to stimulate specific types of house construction 

is necessarily the most efficient way to go about it. Probably the 

better thing is to try to ensure strong employment so people have 

the income and they can purchase the home they want to have, or 

they can rent if they prefer. But I do not have the data with me. 

Senator BENNETT. Well, I would appreciate it if we could get 

some because I find this an intriguing idea. I know in Utah, which 

has not been hurt as badly by the housing problem as some other 

States—because we generate something like 30,000 new families 

every year that need houses. But in Utah, above a certain level, 

around $400,000, there is a glut of houses on the market and, 

therefore, nobody in that market or above can sell their house. But 

for houses in the $200,000 area, which we would now begin to 

think of as an affordable housing range, there does seem to be 

something of a shortage. 

So if you have any data on that that you could share with us, 

I would appreciate it. Because as we formulate the stimulus package, Mr. Chairman, this is something I think we ought to look at. 

It is a little more sophisticated and has drilled down through the 

data to a more granular level. But anything we can do to get the 

construction business started—you say, well, it is maybe too long 

term out, but there are a lot of jobs that people can get in the construction business if they are building the lower-priced houses that 

right now the construction workers do not have anything to do. 

Mr. BERNANKE. Senator, one thing that is certainly true is that 

a lot of the big house price declines are taking place in high-priced 

areas like California and Florida, Nevada, Arizona, where prices 

went up a lot before, and now they are coming back down. 

Senator BENNETT. That is the price range that it is hitting in 

Utah as well. 

Thank you, Mr. Chairman. 

Chairman DODD. Not at all. And I might have missed this in 

your point here, but seemingly one of the issues we are grappling 

with here is the oversupply. And you are raising a different question. Where is that oversupply occurring? But one of the concerns 

I have is that allowing the market to take over here, if your supply 

increases and demand is not keeping pace, then obviously your 

ability for the market to really help stabilize this problem here is 

going to be de minimis, it seems to me. 

22 

Senator BENNETT. My point is that the market is not monolithic. 

There is an oversupply at the high range, but I am being told that 

in the lower range—— 

Chairman DODD. Well, that is a good question and one we ought 

to—if you have the ability to give us some information on that, I 

would be very interested in that as well, Mr. Chairman. 

Let me turn to Senator Menendez. 

Senator MENENDEZ. Thank you. 

Thank you, Mr. Chairman, for your testimony and your service. 

It seems to me—and I am sure all of us—that the central bank is 

faced increasingly with the contradictory pressures of the slowing 

economy and rising consumer prices—gas prices, food prices, energy prices as a whole, to name a few. Isn’t revving up a slow economy far easier than slowing inflation once it has become entrenched? 

Mr. BERNANKE. As you say, if it becomes entrenched, if inflation 

expectations were to rise and that were to lead to a wage-price spiral, for example, or, non-energy, non-food prices rising more quickly, that would be more of a concern. As I said, we are concerned. 

I do not wish to convey in any way that we are not concerned about 

it. We are trying to balance a number of different risks against 

each other. 

With respect to inflation, as I said, our anticipation is that inflation will come down this year and be close to price stability this 

year and next year. If it does not, then what we will be watching 

particularly carefully is whether or not inflation expectations or 

non-energy, non-food prices are beginning to show evidence of entrenchment, of higher inflation, as you point out. That would certainly be of significant concern to us and one that we are watching 

very carefully. 

Senator MENENDEZ. Let me ask you, with consumers reluctant to 

spend and businesses reluctant to invest and lenders reluctant to 

lend and home prices going downwards, is the lower interest rates, 

do you believe, going to be enough to do the trick? 

Mr. BERNANKE. Well, I think it is certainly helpful, and we also 

have a fiscal package, as you know. A lot is going to depend on the 

underlying resilience of the economy itself and of the financial system to work through these problems and to bring us back to a situation where we can grow in a normal way. 

Senator MENENDEZ. How about something that you do not have 

control over, which is the foreign confidence in the American dollar? Isn’t your ability to continue to cut rates to some degree restrained by the willingness of foreign countries to continue to finance the current account deficit? 

Mr. BERNANKE. Well, it is a complex question. We—— 

Senator MENENDEZ. Can you give me a simple answer? 

Mr. BERNANKE. I will try. It is important for the U.S. economy 

to be strong and an attractive place for investment. And I think we 

are better off in the medium term trying to ensure good, strong 

growth in the economy to attract foreign investment than we are 

falling behind and allowing the economy to drop into a severe decline. 

So there is a balance there. We have to think about the shortterm return, which is partly related to our interest rate decisions, 

23 

but we also need to think about the medium term, where we want 

to make sure the economy is growing in a stable and healthy way 

which will attract foreign investment. 

Foreign investment, I should emphasize, continues to be strong. 

We are not seeing any significant shifts of out of dollars among official holders, for example. And I anticipate that we will continue to 

have the capital inflows we need, in part, going back to my earlier 

comments, because I do think that the world recognizes that the 

U.S. economy has underlying strengths and resilience that will 

bring us back to a strong growth path within the next couple of 

years. 

Senator MENENDEZ. If then the Fed’s decision at this point in 

time—of course, it always depends upon the point in time—is that 

dealing with the slowing economy is the present priority, and as 

the Chairman has said on more than one occasion, that if there is 

a great challenge in the economy, it stems from the mortgage meltdown, the housing market meltdown, are we—I have a real concern. You know, in March of last year, I and a few others said we 

are going to have a foreclosure tsunami, and everybody poohpoohed that and said that is an overexaggeration. And, unfortunately, we are well on our way, and we have not even seen the totality of it. 

The question is, when I see the Center for Responsible Lending 

say that basically the present administration’s plans will only deal 

with 3 percent of the properties, removing them from foreclosure, 

and I see Moody’s saying that the experience of 2007 is largely 

around 3.5 percent of workout, at the end of the day is a 97-percent 

market correction something that we are willing to accept and 

something that we need to accept? Or is that a percentage that is 

far too high? 

Mr. BERNANKE. Senator, there have been about four or five studies reviewing the experience of servicers and lenders and trying to 

work out mortgages, and, unfortunately, we are still getting a very 

mixed and fuzzy picture about exactly what is happening. One of 

the benefits, I think, of some of the recent actions associated with 

the Hope Now Alliance, for example, is that I hope we will be getting better, more up-to-date, and more consistent data on what is 

actually happening in the field. 

I do agree that while the servicers seem to have made some 

progress in scaling up their activities, they are not yet to the point 

where they can deal with what you called the ‘‘tsunami of foreclosures,’’ which is already well underway. And for that reason, we 

continue to urge them to expand their efforts further, to work toward more permanent solutions. 

Senator MENENDEZ. But if that were to be the figure, is that an 

acceptable market correction figure, 97 percent of the couple of million families in this country ready to lose their home? Is that what 

we are willing to accept, both in the context of public policy as well 

as in the context of our economy? 

Mr. BERNANKE. Well, even under regular circumstances, unlike 

what we have today, the number of foreclosure starts that actually 

ends in an eviction or a sale is well less than 97 percent. So I am 

not quite sure what to compare it to. Obviously, the more people 

who are able and desire to stay in their home, the more we can 

24 

help, the better that is going to be. And I strongly support increased efforts by the servicers and lenders to address this issue. 

Senator MENENDEZ. Well, my concern is we were behind the 

curve in trying to deal with the issue, and my concern is now we 

seem to be continuing behind the curve in stemming the hemorrhaging that is going on. 

One last question. The central bank has always seen its core mission as safety and soundness. Consumer protection I hope is going 

to increasingly be something that you will consider a core mission 

as well. And I heard your remarks at the very end of your testimony. 

Is it your intention—when you talk about issuing something on 

unfair and deceptive practices, is that in relation to credit cards, 

mortgages, to REITs? Is it cross-cutting? 

Mr. BERNANKE. We have already issued the HOEPA rules, which 

address unfair, deceptive acts and practices relating to mortgages, 

for comment. We are currently receiving comments on those. 

The new rules, which I alluded to, for the spring are under the 

FTC unfair, deceptive acts and practices code, and they would 

apply to credit cards, and possibly other things, but primarily credit cards. 

Senator MENENDEZ. Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much. 

Senator Allard. 

Senator ALLARD. Thank you, Mr. Chairman, and thank you, 

Chairman Bernanke. 

Mr. Chairman, we have to, I think, remind ourselves exactly 

what is involved in a recession. I hear the reporters, I think erroneously, reporting a recession when actually we are having an economic slowdown. I would like to have you define for the Committee 

what would constitute a recession. 

Mr. BERNANKE. Well, recessions are generally called, so to speak, 

by a committee called the Business Cycle Dating Committee, which 

is part of the National Bureau of Economic Research—a committee 

of which I was once a member, by the way—which looks at a wide 

variety of indicators to see essentially if the economy contracted 

over a period of time. It is a somewhat subjective decision, and it 

is often made well after the fact because of the revisions of data 

and so on. 

A more informal but widely used definition of recession is two 

consecutive quarters of negative growth. That would be an alternative that people use. 

Senator ALLARD. There was a newspaper article or report that 

came out, I think in the last day or two, suggesting that somehow 

or other the Federal—or you and the Fed may be running out of 

tools to control inflation. Do you have a comment on that comment? 

Mr. BERNANKE. Well, as I said, we are trying to use our principal 

tool, which is the Federal funds rate, to balance the various risks 

that we see in inflation and growth and financial stability. We do 

not really have additional tools on inflation. We do have additional 

tools to deal with financial problems, such as, the term auction facility, which we are currently using, and other steps that we have 

taken or could take. 

25 

With respect to inflation, I think our principal tool would be the 

interest rate. 

Senator ALLARD. Now, the Congress, through public policy, I 

think on a macro scale, may have some impact on the economy. 

And in general terms, if the Congress was to increase spending, 

what do you feel would—what kind of an impact would that have 

on the economy? And then look at the other side. Suppose Congress 

would increase taxes. What kind of an impact would that have perhaps on today’s economy where we are standing? 

Mr. BERNANKE. Well, from a short-term aggregate demand viewpoint, spending tends to add to demand, and if the economy is at 

a point where its resources are not being fully utilized, it could lead 

to more increased utilization of resources; whereas, higher taxes in 

a short period of time, if it reduces consumer spending, for example, could lead to less use of resources. 

The Congress has passed a fiscal stimulus package which tries 

to address the issues of aggregate demand and sufficient demand 

for utilization of resources. I would urge the Congress, in looking 

at additional spending and tax plans, to think about the underlying 

effects on the efficiency and effectiveness of the economy, that is, 

not to make decisions based on short-term demand considerations 

but to think about how these spending programs or tax programs 

affect how well the economy will grow over the long term. 

Senator ALLARD. So you are thinking about Social Security, 

Medicare, and Medicaid primarily on those costs, I would assume? 

Mr. BERNANKE. Well, and from a fiscal perspective in the longer 

term—and by longer term, I means only a few years from now because we are coming very close to the point where the baby-boom 

generation is going to begin to retire in large number. By far, the 

biggest issue is entitlements, particularly the Medicare part, but 

Social Security as well. 

Senator ALLARD. Yes, I appreciate those comments. 

The other thing, you talk about, you know, inflation being 

pushed by energy and food costs. What is offsetting that? There 

must be some—to come out with an average of 2 percent, a little 

over 2 percent, there must be somewhere over here where we are 

getting a lesser amount that is offsetting those increases. Where do 

you see that happening? 

Mr. BERNANKE. Well, what we saw in 2007 was about 2-percent 

inflation excluding energy and food. When you add on the energy 

and food, you get something more like 3.5 percent by our preferred 

indicator, which is obviously a high rate of inflation and we are not 

comfortable with. 

Senator ALLARD. So you do not see a sector of the economy that 

is being driven down in a way that it has an offsetting effect. You 

are just seeing this just averaging out as a part of the average. OK. 

We have on ethanol, for example, on energy, we have a really 

high tariff. It is 51, 52 percent. And energy builds into the whole 

economy. It is a fundamental driver. 

What do you think about us looking at reducing some of those 

high tariffs like that? What kind of an impact would that have on 

our economy? 

26 

Mr. BERNANKE. Well, Senator, as you know, I favor open trade, 

and I think that allowing Brazilian ethanol, for example, would reduce cost in the United States. 

Senator ALLARD. And is that—when you look at the food—the 

way I look at it is when you have an ethanol—you have your food 

products being diverted to ethanol production, it has an impact on 

both food as well as the cost of energy and whatnot. Is it a significant enough part of the economy that we need to look at that more 

seriously? 

Mr. BERNANKE. I do not have an estimate of the overall effect. 

I think it would be hard to do. But it is the case that a significant 

portion of the corn crop is now being diverted to ethanol, which 

raises corn prices. And there are some knock-on effects; for example, some soybean acreage has been moved to corn production, 

which probably has some effects on soybean prices, too. So there is 

some price effect on foodstuffs coming through the conversion to energy use. 

Senator ALLARD. Well, you know, the wheat farmers in my State 

are saying that wheat is at a historic high for them, and so I wonder just, you know, how much of that—I suppose, again, that is a 

dryland crop, but there is some conversion to dryland corn. But, 

again, that seems to have some impact on the grains in general, 

and the poultry people and the livestock people—well, all livestock 

people—swine, poultry, and beef in particular—all have concerns 

about that. So I was curious to see how you were evaluating that 

policy in respect to the total economy, and obviously you do not 

have too much to say on that because you do not think it is too 

big a part of the economy. Is that right? 

Mr. BERNANKE. Well, again, I do not know quantitatively how big 

the effect is, but there is some inflationary pressure coming 

through foods, including corn and soybeans, and obviously other 

crops like wheat which have suffered various supply problems in 

the last year. 

Senator ALLARD. Yes, OK. Well, Mr. Chairman, I see my time 

has run out. 

Chairman DODD. Great questions, too, and we will come back to 

those maybe in a little bit. Senator Reed was raising with me privately the issue as well, and I think it is worth exploring. The issue 

of the question of the value of the dollar, the rising price of oil, the 

dollar denomination oil pricing, whether or not that can shift in 

these commodities generally is an interesting issue. 

But let me turn to Senator Bayh. 

Senator BAYH. Thank you, Mr. Chairman. 

Mr. Bernanke, thank you for you—Chairman Bernanke, I should 

say. Thank you for your presence today, and thank you for your 

service to our country. I think you have your priorities right. You 

mentioned that the risks in the forecast are to the downside and 

that our principal concern at this moment—you have to strike a 

balance, but our principal concern should be avoiding an economic 

downturn of severity and duration while continuing to focus on inflation in the longer term. 

As you and some of my colleagues have pointed out, the genesis 

of much of this originated in the housing sector, particularly with 

some of the subprime type mortgages. And it seems to me that you, 

27 

in setting monetary policy, erred on the side of—not erred, but you 

have been more aggressive than less and tried to minimize the 

downside risk to the economy. And that is as it should be. 

My question to you is: Should not Congress do the same in addressing the housing problem? The President has the voluntary 

Hope Now initiative you have outlined. I think it would be charitable to say that the results of that have been modest to date. You 

indicate there is not a lot of data, but it certainly does not seem 

as if it has had much of an impact. 

There are some proposals, fairly narrowly circumscribed ones before us, that would focus on this issue, allowing bankruptcy courts, 

only with regard to outstanding subprime mortgages, to revisit 

some of these issues, only when the borrowers have passed a strict 

means test. The interest rates would be set at prime plus a risk 

premium, and if the homes were ever resold, the lenders would 

participate in the upside, any potential upside, if the property 

would revalue. 

Now, the President has threatened to veto this initiative, and 

some have claimed that it would add as much as 2 percent to the 

cost of a mortgage. I find that to be not a credible analysis when 

it, by definition, does not apply to future mortgages. This is a oneoff event, the greatest housing downturn in the last 50 years, fairly 

narrowly circumscribed. 

So my question to you is: Just as you have emphasized being 

more aggressive at this moment, should not we? And as an economist, is it credible to think that this would add 2 percent to the 

cost of a mortgage moving forward in this narrowly circumscribed 

manner? 

Mr. BERNANKE. I do not know how much it would add. I think 

it would probably add something because the collateral would be 

less secure. 

Senator BAYH. This only applies to past loans, by definition, not 

future ones. 

Mr. BERNANKE. Well, then the question is raised: Will this happen again? 

Senator BAYH. Well, every 50 years when we have a calamity 

like this, maybe so. 

Mr. BERNANKE. You know, I see concerns on both sides of this, 

and I understand the rationale for wanting to make those changes. 

I also see some concerns about the effects on the marketplace and, 

for example, on holders of current loans, how they would react. 

Senator BAYH. There are some implicit risks in the more aggressive monetary policy you have pursued. 

Mr. BERNANKE. Monetary policy is my domain, and I—— 

Senator BAYH. My point is and the question I am raising, just 

as you have been more aggressive—and appropriately so—should 

not we? 

Mr. BERNANKE. I think there is an argument for being aggressive 

in general, but I would just decline, if you would permit me, to endorse that particular action. I am really at this point focused on 

FHA and GSE reform as being two useful steps in the direction of 

helping the housing market. And we should continue to think 

about alternatives. But at this point I do not have, good additional 

measures to suggest to you. 

28 

Senator BAYH. Well, I do not want to put you in the business of 

getting into the debate between the legislative and executive 

branches here, but I do think at this moment, as we have all recognized, this is a perilous moment for the economy. It seems to me 

that there are risks on either side, but the balance here, it seems 

to me, lies on being a little more aggressive than less. And that 

ought to apply to all aspects of our policy, not just one particular 

subset. 

We have had a big discussion here about inflation versus growth. 

Again, I think you have your priorities right in that regard. You 

have pointed out that the core rate, while modestly above target, 

has—the principal thing driving this in the near term has been 

food and energy costs, and that you do not see any persistent rise 

in the core over the longer term. 

My question, Mr. Chairman, is: What indicia of economic stability or greater growth would alleviate your concerns and would 

allow you to then perhaps pivot and focus on the inflation concern 

more than we currently are? 

Mr. BERNANKE. Well, Senator, first, I do not want to leave the 

impression that we are looking only at one—— 

Senator BAYH. No, no. You were very balanced. 

Mr. BERNANKE. We are always trying to balance these risks and 

always trying to continually re-weight our thinking about the different risks to the economy. 

Senator BAYH. Maybe a better way to put my question would be: 

When will the risks be back in equilibrium as opposed to—what indicia will you look at to reassure yourselves that the economy is 

stabilized and growth is resumed at an acceptable level? 

Mr. BERNANKE. One of the concerns that I have is that there is 

some interaction between the credit market situation and the 

growth situation—that is, if the economy slows considerably, which 

reduces credit quality, that worsens potentially the condition of 

credit markets, which then may tighten credit further in a somewhat adverse feedback loop, if you will. I think that is an undesirable situation. I would feel much more comfortable if the credit 

markets were operating more nearly normally and if we saw forecasted growth—not necessarily current growth but forecasted 

growth—that looked like it was moving closer toward a more normal level. 

So what I would like to see essentially is a reduction in the 

downside risks which I have talked about, particularly the risk 

that a worsening economy will make the credit market situation 

worse. 

Senator BAYH. Well, let me ask you—but I have got only 1 

minute so I am going to need to hurry. I did have two questions. 

What aspect of the credit markets will you look to? And, in particular, I have been interested—you talked about the flight from 

risk. There have been some aspects of the credit market that seem 

to me to be almost without risk, and yet people are fleeing from 

those as well. These auction rate securities, very short term, the 

underlying assets, particularly in the municipal sector, virtually no 

risk of default, and yet that seems to have seized up as well. 

What do you think will lead people to begin to assume rational 

levels of risk again? And what indicia will you look to in the credit 

29 

markets to reassure yourself that this situation is beginning to 

work itself through? 

Mr. BERNANKE. Well, there is reluctance to take risk, and there 

are also concerns about understanding exactly what a particular financial asset consists of. And there are still some issues of transparency and so on that need to be worked out. 

I think that a stable situation would be one in which good quality credits like, major municipal borrowers would not have difficulty in getting credit, and the issue would be the same for good 

quality credits of firms and households as well. 

So when you see a pulling back, and seeing the problem spread 

through a variety of markets, which is interfering with the normal 

flow of credit, then obviously that is not a normal, healthy situation. 

Senator BAYH. Mr. Chairman, I have just one—my final question. Mr. Chairman, it has been visited by a couple of my colleagues; particularly Senator Reed I thought was excellent in his 

questioning. It has to do with the credit agencies. We had a couple 

of very capable individuals come before our caucus to focus on some 

of these economic concerns, and the issue of the rating agencies 

came up. And one of them, in response to my question about—markets can operate efficiently, but that presumes they have access to 

accurate information. In this case, you know, clearly that was not 

always so. And this is the problem with the credit markets in part 

you have pointed out here. So what can we do to avoid this again? 

You have mentioned that you and your people are looking at that. 

But when I asked the question, this individual said, ‘‘Well, I am 

not sure any additional action by the Government is necessary. The 

market will work this out. These rating agencies, their share prices 

will be punished and, therefore, they will have an incentive to not 

do this again.’’ 

But whether it is in regard to certain types of Latin American 

credit or other areas, it seems that the markets have a way of forgetting the lessons of history, focusing on short-term decision making, every 7, 8, 10 years or so, and we kind of end up in some of 

these problems again. And the consequences to the broader economy here have been so profound and so great, it seems to me, that 

in addition to relying on the market, perhaps there should be some 

parameters to ensure that we do not end up in this situation again, 

which leads us to either regulatory or legislative action. 

So, just broadly speaking, do you think that some additional actions, either regulatory or legislative, may be in order to ensure 

that this situation does not repeat itself in the future and that we 

do not just simply rely upon the punishment of the market to prevent this in the future? 

Mr. BERNANKE. Well, regulatory action is already being contemplated. The Securities and Exchange Commission, which has 

authority over the credit rating agencies, is reviewing the situation, 

and seeing whether additional steps need to be taken. Of course, 

the Congress already gave the SEC some powers, which they have 

begun to implement. 

The fault lies on both sides of the equation, if you will—with the 

credit rates, but also with the investors, who over-relied on those 

ratings and did not do sufficient due diligence. In that respect, as 

30 

I mentioned before, the Basel Committee is looking at the use of 

ratings in risk measurement for banks, and I would encourage the 

regulators of pension funds and other investors, for example, to ensure that investors do due diligence over and above simply looking 

at the rating and assuming that is all you need to know. 

Senator BAYH. Thank you, Mr. Chairman. 

Chairman DODD. Thank you, Senator, very, very much. Again, 

some very, very good questions. 

Senator Bunning. 

Senator BUNNING. Thank you, Mr. Chairman. My opening statement I will submit for the record. 

Chairman DODD. By the way, I should have made that point. All 

opening statements and any supporting documents people want to 

have will all be included in the record, and I appreciate you raising 

that. 

Senator BUNNING. Chairman Bernanke, can you explain what information or event caused the Fed to change its view on the conditions of the economy and the financial markets and led to the January 21 intermeeting rate cuts? 

Mr. BERNANKE. Yes, Senator. First of all, as you know, we cut 

rates by about 100 basis points during the fall, reacting to the drag 

on the economy arising from the housing markets and from the 

credit market situation. Around the turn of the year and early in 

January, the data took a significant turn for the worse, and it 

seemed clear that the economy was slowing, and slowing more than 

anticipated, and that the credit market condition situation was continuing. 

On January 9, I called a meeting of the Federal Open Market 

Committee by video conference to discuss the situation. It was 

agreed by the committee that some substantial additional cuts in 

the Federal funds rate were likely to be necessary. The thought at 

the time of that meeting was that it might be worth waiting until 

the regular meeting at the end of the month where we could have 

a fuller discussion and see the revised forecast and so on, taking 

into account the possibility that we could also move intermeeting, 

if necessary. 

On January 10, I gave a speech where I informed the public that 

I thought that substantive additional action might well be necessary, thereby signaling that the conditions had changed and that 

further rate cuts were likely to happen. 

In the days that followed that speech, the tone of the data deteriorated considerably further, which made me think that the outlook was, in fact, much weaker and the risks were greater. That 

was showing up both in the data and in the financial markets. We 

were seeing sharp declines in equity prices. We were seeing widening of spreads. And we were also seeing, again, adverse data. 

On January 21, I became concerned that the continued deterioration of financial markets was signaling a loss of confidence in the 

economy, and I felt the Fed, instead of waiting until the meeting, 

really needed to get ahead of that and take action. So I called an 

FOMC conference call, and we agreed at that point to cut the Federal funds rate target by 75 basis points. 

There was an understanding at that meeting that further additional action was very likely to be needed, but we felt that we could 

31 

wait another 10 days until the regular meeting to determine exactly how much additional action. At the meeting at the end of 

January, we had a full review, discussion, forecast round and so on 

and determined that an additional 50 points was justified. 

Looking back, as the data have evolved, I think that the 125 

basis points was appropriate for the change in the tone of the economy, and I think it was the right thing to do. 

Senator BUNNING. Are the days of constant and gradual Fed rate 

changes over? In other words, are large and intermeeting rate 

changes going to become a regular part of the Fed toolbox now? 

Mr. BERNANKE. I cannot make any guarantees, Senator, but in 

general, we prefer to move at the regularly scheduled meetings. As 

I said, that is a chance to get together in Washington and to have 

a full briefing by the staff and to have all the information made 

available to us. 

Senator BUNNING. How about which do you see as a greater 

threat to the economy, a credit crunch now or higher inflation in 

the future as a result of efforts to stop a credit crunch? 

Mr. BERNANKE. Senator, we have to keep balancing those things. 

As I said, our current view is that inflation will moderate this year 

as oil and food prices do not rise as much this year as they did last 

year. We are also watching very carefully to make sure that higher 

oil and food prices do not feed into other costs and into other prices 

or that inflation expectations do not become unanchored. If those 

developments began to happen, that would certainly force us to pay 

very serious attention. 

At the moment, I think the greater risks are to the downside— 

that is, to growth and to the financial markets; but, again, we are 

always vigilant on all of our objectives and are always trying to 

balance those risks against each other. 

Senator BUNNING. You read the Wall Street Journal. I am very 

sure of that. Today, in the Wall Street Journal, ‘‘Report on profits 

a bright spot in the gloom. The Dow Jones Industrial Average has 

gained 6 percentage points since the first day of the year.’’ In the 

Standard & Poor’s index, 462 corporations have reported their 

earnings for the fourth quarter; 62 percent of those that have reported topped their earnings estimates—62 percent. If you drop out 

financials, carve out financials, which were 12 percent lower, the 

gloom and doom that I have heard here today is not gloom and 

doom. Are you going to tell me that these same corporations that 

reported—and we had a really low growth rate in the fourth quarter—are going to be worse in the first quarter? Or are we also 

going to have the same kind of reporting in the first quarter of 

2008 that this profit report on the Standard & Poor’s and the Dow 

is not as accurate in the first quarter as it was in the fourth? 

Mr. BERNANKE. Well, Senator, you are absolutely correct that 

profits at the nonfinancial firms have remained pretty good. I do 

not have with me an estimate of the profits for the first quarter. 

But firms seem to be indicating concerns about the future. For example, if you look at the ISM survey of non-manufacturing industries, it dropped very significantly a few weeks ago, suggesting a 

good bit more pessimism on the part of firms. 

Senator BUNNING. But isn’t one of the real signals that we really 

have to watch the unemployment rate in the United States of 

32 

America? And that moved from 4.9 to 5 percent in the fourth quarter. And where is it now? Where do you estimate it to go in the 

first quarter of 2008? 

Mr. BERNANKE. It jumped in December from 4.7 to 5.0, which is 

a pretty significant jump, and it was certainly something that we 

looked at. And—— 

Senator BUNNING. Well, that was kind of indicated by the low 

growth rate and the reasonable expectation that the job rate would 

be higher, unemployment in the fourth quarter. I am asking about 

2008. 

Mr. BERNANKE. Well, I reported our projections for the fourth 

quarter, which were 5.2 to 5.3 percent in the fourth quarter. We 

are seeing unemployment insurance claims rising, which I think is 

consistent with the somewhat higher unemployment rate going forward. 

Senator BUNNING. What are you telling me? 

Mr. BERNANKE. That the unemployment rate is likely to go up 

from here. 

Senator BUNNING. How bad? Are you saying 5.6, 5.7? 

Mr. BERNANKE. The baseline projection we have made for the 

fourth quarter is 5.2 to 5.3, but there are downside risks. Things 

could get worse than that. We do not know. But it is not our main 

projection. It is just a risk that we see out there. 

Senator BUNNING. Then does that bode well with the lowering of 

interest rates and the higher rate of unemployment? That indicates 

to me that someone in the Journal today that talked about stagflation might be talking more sense than we might anticipate. 

Mr. BERNANKE. Well, again, Senator, we are just trying to balance the risk of growth, inflation, and financial stability. Monetary 

policy works with a lag, and, therefore, we have to—— 

Senator BUNNING. Well, I understand that very clearly. We 

should have lowered rates earlier, and all of a sudden we lowered 

them 2.25 points—225 basis points in less than—what?—6 weeks, 

8 weeks. 

Mr. BERNANKE. It was 125. 

Senator BUNNING. 125. 

Mr. BERNANKE. Yes, Senator. 

Senator BUNNING. Well, if you count the fourth quarter of last 

year, what was the total? 

Mr. BERNANKE. We lowered 50 basis points in September, 25 in 

October, 25 in December, and 125 in January. 

Senator BUNNING. Then it was 225. 

Mr. BERNANKE. Not in the fourth quarter. 

Senator BUNNING. No, no. Total. Total since the last—— 

Mr. BERNANKE. That is right. 

Senator BUNNING. That is considerable, and the market conditions indicated that that was absolutely necessary. 

Mr. BERNANKE. I think so. The housing market decline and the 

weakness in the credit markets were suggestive of—— 

Senator BUNNING. Well, the weakness in the credit markets, 

Chairman Bernanke, were signaled last year, early in the year. I 

mean, it was not—it did not take a rocket scientist to figure that 

out. And I know with all the great economists that you have on the 

Federal Reserve and your members of the Federal Open Market 

33 

Committee are a lot sharper than the people sitting up here at this 

table. And you had a big heads-up signal that the housing market 

was in the tank early last year. 

Mr. BERNANKE. But the housing market was not affecting the 

broad economy. When we lowered interest rates on the last day of 

October, that morning we received a GDP report for the third quarter of 3.9 percent, which was subsequently revised to 4.9 percent, 

and inflation was a problem. So, in fact, I think if we look back on 

this episode, we will see that the Fed lowered interest rates faster 

and more proactively in this episode probably than any other previous episode. 

As you point out, the unemployment rate is still below 5 percent, 

and—— 

Senator BUNNING. I lived through the Greenspan years. I know 

exactly what you are talking about. 

Thank you. 

Chairman DODD. Thanks very much. 

Senator Schumer. 

Senator SCHUMER. Mr. Chairman, with your and the Committee’s permission, Senator Tester has to be somewhere at noon and 

so do I, so I volunteered to split my time with him and let him ask 

the first question and leave, and then I will—if that is OK with you 

and the rest of the Committee. 

Chairman DODD. Fine. 

Senator TESTER. Thank you, Senator Schumer, and thank you, 

Mr. Chairman, and thank you, Chairman Bernanke. I appreciate 

your forthrightness today and always. 

I want to talk about commodities for a little bit. I am a farmer. 

I am happy when commodities go up. But as was earlier pointed 

out today, oftentimes this can end up potentially like it was in the 

1970s when we saw a big commodity raise; we saw the inputs that 

went into agriculture go through the roof; we saw food prices on 

the shelf go up because commodity prices were higher; and then 

commodity prices fell back. Those inputs that went into production 

agriculture stayed up, and the food on the shelf stayed up, too, because they said there was not enough wheat in a loaf of bread to 

make a difference after they raised the prices because commodities 

went up. 

My question to you is: Do you see that playing out the same 

way? I mean, we are going to see food prices go up probably, it 

would be my guess. We already have. And we have already seen 

inputs go up on the farm for production agriculture. I anticipate 

this commodity price will not stay where it is at forever. They usually do adjust, and they usually adjust down. And food prices will 

stay up, inputs will stay up. Do you see that same thing happening 

again? And is there anything we can do if it is that way? 

Mr. BERNANKE. If commodity prices come down, including energy 

prices and raw food prices, I would expect to see, perhaps with a 

lag, finished food prices come down as well. As we have been discussing, the commodity prices, both food and energy, have been the 

primary source of the recent inflation. If they stabilize, even if they 

remain high, then inflation will moderate. And I expect that would 

happen, at least over time, at the finished level as well as at the 

raw level. 

34 

Senator TESTER. OK. Thank you very much, and I want to thank 

Senator Schumer again. Thank you very much. 

Senator SCHUMER. My pleasure. 

Two questions, Mr. Chairman. The first involves these sort of 

combination, creating problems now, of marking to market and the 

credit crunch, freeze, call it what you will. You know, when I first 

got here on the Banking Committee, banks really did not mark to 

market, and we regarded it as great progress that they now have 

to mark to market, like securities firms and others always did. It 

is a proper valuation of their assets. 

The problem here is nobody knows how to mark to market because there is no market. In too many areas, no one is buying. And 

so you do not know what they do when they make a valuation. I 

have heard from many people that that valuation is—they make it 

artificially low, and that further exacerbates. It is a vicious cycle 

because then they do not have the capital, they cannot do any more 

lending, and everything is frozen up. 

Is there a way to deal with that problem now? Is there a way 

to say, yes, you have to mark to market, but in these unusual circumstances you can do it 6 months from now, or something to that 

effect, quarterly, yearly? 

I am not an expert here, but I do know it is a real problem. How 

do you mark to market when there is no market? And because 

there is no market, rare, almost never occurred in such large parts 

of the credit market before, is this an unusual circumstance where 

this does not work? 

And my second question—and I will ask you to answer both—is 

this: The worry I think people have—and we have seen some questions on this—is that it is a lot easier to get the economy going 

than to shut inflation off. And the worry is that we go back to the 

situation in the late 1970s where the economy was stalling, rates 

were lowered, and then there was nothing that the Fed could do 

other than very late and drastic action to curb inflation. It was a 

difficult struggle. We went through it in the 1980s, and I remember 

paying 21 percent on my mortgage when I first signed my mortgage in 1982. 

Do we have better tools now that can control, you know, if inflation should start going beyond what you imagine for all the—we 

are global economy. You have less experience and less tests in this 

interconnected world than you did 20 years ago. Do we have better 

tools? Are you worried that if inflation really starts chugging along, 

that even a quick raise in interest rates will not be able really to 

head it off without really severe damage to the economy? 

So those are my two questions. 

Mr. BERNANKE. Thank you, Senator. On the first one, you raise 

a very good point. The Federal Reserve has long had sort of a 

mixed view about fair-value accounting. We think that markettraded assets should be valued at the market price and that investors are entitled to know what that price is. But we have always 

recognized—and we had in mind things like bank loans, for example, that are relatively illiquid—that it might be difficult to value 

them on a fair-value basis and that there could be problems arising 

there. 

35 

As you point out, we now have a situation where some assets 

which are normally tradable are perhaps not generally tradable. 

The accounting profession has created a system which, attempts to 

get around that problem. There are these three different levels 

where you have a market valuation or a model valuation or a judgment valuation. 

I think that is one of the major problems that we have in the 

current environment. I do not know how to fix it. I do not know 

what to do about it. I think the accountants need to make the best 

judgment they can. 

Senator SCHUMER. Some have suggested, you know, delaying a 

mark to market, even using this system until there is a market 

and letting the—because you really do not know the value of the 

asset. And if you undervalue it, you may be hurting things as much 

as if you overvalue it. 

Mr. BERNANKE. I understand your concern, Senator, but the risk 

on the other side is that if you do too much forbearance or delay 

mark to market, that the suspicion will arise among investors that 

you are hiding something. 

Senator SCHUMER. Right. What about a rolling average that 

takes into account 6 months back? 

Mr. BERNANKE. Senator, I have not worked through any proposals like that. This is really an Accounting Board responsibility. 

I agree there is a severe problem. It is difficult to change the rules 

in the middle of a crisis. 

Senator SCHUMER. I know. 

Mr. BERNANKE. It is one of those things that we are going to 

have to put on the list of issues to evaluate as we try to learn the 

lessons from this experience. 

Senator SCHUMER. But you do admit it is a serious—it is one of 

the nubs of the problem now, even though it has not been talked 

about that much. 

Mr. BERNANKE. And the direction of how to fix it is not at all 

clear. 

Senator SCHUMER. OK. Second question. 

Mr. BERNANKE. On your second concern, I think we are better off 

now than we were in the 1970s in that there is a much broader 

recognition of the importance of price stability and greater confidence that central banks will deliver price stability. The indicia 

of inflation expectations, where some of them have moved a bit, are 

basically stable. We have not seen any major shift in views about 

inflation and where inflation is likely to go. The Federal Reserve 

has emphasized the importance of maintaining price stability and 

has indicated that we will watch very carefully and make sure that 

we do not see any deterioration in either broad measures of inflation expectations or increased pass-through of food and energy 

prices into other prices. We will watch those carefully and we will 

respond—— 

Senator SCHUMER. But do you believe if you miscalculate and inflation starts coming out of the box more quickly than you think, 

do you have tools to deal with that or is that still a very difficult 

area, once inflation rears its head, it is very hard to put the genie 

back in the bottle? Or are we much better at it now than we were 

20 years ago? 

36 

Mr. BERNANKE. Well, if higher inflation were to become well embedded in inflation expectations and wages and other parts of the 

economy, it would be difficult, and we do not really have new methods. It is a risk, and we take it very seriously, and we are monitoring it very closely. But as I have said several times, we are dealing with a number of different concerns here, and we are trying—— 

Senator SCHUMER. I know. It is not easy. 

Mr. BERNANKE. ——the risks as best we can. 

Senator SCHUMER. Thank you, Mr. Chairman, and I thank my 

colleagues. 

Chairman DODD. Well, thank you very much, Senator, very 

much. 

Senator Dole. 

Senator DOLE. Thank you. 

Mr. Chairman, I do not have to tell you that my State of North 

Carolina has lost a lot of manufacturing jobs over recent years, and 

you and I have had discussions about job retraining programs. I 

am very pleased that Congress has now begun to debate the best 

way to reform the Trade Adjustment Assistance, the TAA Program. 

And I would like to ask your opinion about what you feel the impact would be of congressional reauthorization and if there are any 

particular aspects of reform that you would want to suggest for the 

workforce of the 21st century. 

Mr. BERNANKE. Well, Senator, as I have argued in a number of 

speeches, for example, globalization and trade have a lot of benefits, but they also have some costs. They cause dislocation. They 

cause loss of jobs. And my view is that the best way to deal with 

that problem is not to shut down trade but, rather, to help those 

who are affected adjust to their circumstances. 

Senator DOLE. Right. 

Mr. BERNANKE. And so as a general matter, we should look for 

ways to help people through skill acquisition or other kinds of assistance that allow them to take advantage of the new opportunities to replace the ones that they lost. 

I do not want to comment on specific elements. I know there are 

some competing TAA bills being considered, and I think that is 

really up to Congress to make those detailed decisions. But I do 

think that it is much better than shutting down trade to try to help 

people adjust to the effects of trade. 

I had the opportunity recently to speak in Charlotte, and one of 

my themes there was although North Carolina certainly has lost a 

lot of manufacturing jobs, if you look at the city of Charlotte and 

how it has reinvented itself to become a financial center, a services 

center and a center for the arts and many other things, there is 

a tremendous opportunity in a dynamic economy, as the one we 

have, to find new opportunities, to find new businesses and industries. 

And so rather than try to freeze the industrial structure the way 

it is, we are better off helping people move to the new opportunities, and TAA is one potential way of trying to assist that process. 

Senator DOLE. Thank you. Mr. Chairman, let me ask you about 

Sarbanes-Oxley. Some smaller banks appear to be clearly overburdened by compliance with Sections 404 and 302. These financial inVerDate Nov 24 2008 10:00 Jul 31, 2009 Jkt 048080 PO 00000 Frm 00040 Fmt 6633 Sfmt 6633 S:\DOCS\50369.TXT JASON
37 

stitutions are already highly regulated, and it has become increasingly apparent that these regulations, while they were well intended, only increased the cost of doing business. I would really appreciate your comments on what needs to be done here. 

Mr. BERNANKE. Well, it has been recognized that Section 404, in 

particular, imposes a lot of costs. It does have some benefits and 

helps improve internal controls. The Securities and Exchange Commission and the PCAOB have recently issued an audit standard 

which tries to take a more balanced, risk-focused approach to enforcement of 404. And I hope as a general matter that that will reduce the costs while preserving the benefits of Sarbanes-Oxley. 

In the case of banks in particular, there is a good bit of overlap, 

obviously, already with some of the rules that they have to follow 

under existing bank regulations. And I think it would be useful to 

consider where there are redundancies or overlaps that could be reduced in the future. 

Senator DOLE. Thank you, Mr. Chairman. Over recent months, 

much has been written in the financial press regarding whether or 

not key worldwide central bankers—the Bank of England, Bank of 

Japan, European Central Bank, and the United States, et cetera— 

should become more coordinated in their monetary policy efforts. 

Proponents of such efforts point to the current spread between various key country lending rates. 

What is your reaction to this debate? 

Mr. BERNANKE. Well, Senator, first of all, the major central 

banks do cooperate on many things. We meet quite often. I see my 

colleagues at international meetings here and in other countries 

very frequently. We are on the phone together, and we try to keep 

each other apprised of what is happening in our own economies 

and in the global economy, what we are planning, what we are 

thinking. 

We have worked together on some measures recently. In December, when we introduced the term auction facility, we did that in 

a coordinated way with the ECB, the Swiss National Bank, the 

Bank of England, and the Bank of Canada—who also undertook 

various liquidity options at that time. So there is a lot of coordination and cooperation in that respect. 

With respect to monetary policy per se, although we keep each 

other apprised, each economy is in a different place, in a different 

situation, and there is no necessity that each country has to have 

the same policy. I think the policy that is chosen depends on the 

particular circumstances of that country or that region. And so that 

is one of the benefits of having flexible exchange rates to provide 

some insulation, some ability for countries to run independent 

monetary policies. 

And so it has been our practice, as you know, for each major central bank to run an independent monetary policy, and while we 

keep each other apprised, I do not expect to see any extensive coordination in the near future. 

Senator DOLE. Thank you very much. 

Thank you, Mr. Chairman. 

Chairman DODD. Thank you very much. 

Senator Corker. 

38 

Senator CORKER. Mr. Chairman, thank you, and I thank you for 

your testimony. I listened carefully to what you had to say because 

I know you choose your words carefully. You need to because everybody in the world is listening to what you have to say. But I did 

notice that, you know, you mentioned that in every other sector of 

our economy, we are doing well except in the financial area. And 

I noticed that you have mentioned not to make—we shouldn’t make 

decisions for the short term, that as it related to the housing issue 

itself, that you knew of no good additional measures, that you are 

focused on GSE reform and FHA reform. And I know the Senator 

from Indiana talked about on our side being aggressive. I would 

say that what we do ends up being a law that cannot be changed. 

What you do can be changed at the very next meeting, and so you 

have a great deal more flexibility to really look at indicators and 

make changes than we do. Our changes usually stay there for a 

long time. 

I was up at the New York Stock Exchange last week and noticed 

that they are trying to put in place the ability for people to know 

quickly what the value of their credit instruments are, that there 

is not the transparency there that we have in the equity markets. 

And my sense is because there is no transparency today, that even 

if we did not have the subprime issue, because people are making 

money packaging things and selling them off to the next person, 

that even if the subprime market had not tanked the way that it 

had, we still would have had writedowns because people were making so much money off of fees. 

Is that a fair assessment? 

Mr. BERNANKE. Well, I think the subprime crisis sort of triggered 

these events. But it is true that investors have lost confidence in 

a lot of different assets at this point, including, it was mentioned, 

some student loans and other things as well. And part of the problem—not all of the problem, but part of the problem—is that in 

these complex structured credit products, it is very difficult for the 

investor to know exactly what is in there and what derivative support or credit liquidity support is involved. 

Senator CORKER. So, in essence, the subprime issue that has occurred has caused us to look at those in a more healthy way, and 

hopefully the market will create some mechanisms for us to actually value those in real time and create a way for us to have some 

transparency there. Is that correct? 

Mr. BERNANKE. I hope so. But, again, as Senator Schumer suggested, if the accounting industry or the regulators can be of help 

there, I think we ought to try to be of assistance. 

Senator CORKER. You mentioned that leverage was at all-time 

lows in other sectors, and, you know, I still am shocked that when 

we had a credit problem, it was our wisdom to sprinkle money 

around America in an America that already had an incredibly low 

savings rate and ask them to spend it as quickly as possible. And 

I get concerned about actions that we might take here that, in essence—I know you mentioned at the last meeting several times the 

word ‘‘correction.’’ I know Chairman Dodd somewhat chastised me 

at the end because I was pressing for an answer. But do you still 

believe that—and he did so in a very amicable way. I appreciate 

39 

that. But, in fact, do we have a crisis right now in housing, or do 

we have a correction? 

The reason I ask, I look at delinquencies over 30 days. Everything is over 30 days, all the way through foreclosure. And even 

though I know we are having some extreme issues in some of the 

higher-cost housing, it really is not very much different than it has 

been over the last 30 years, only about a percent and a half different as far as delinquencies go. Is this a correction or is this a 

crisis as it relates to housing itself? 

Mr. BERNANKE. Senator, I do not know what terms to use. The 

housing market certainly has come down quite a bit, down to less 

than half the amount of construction that we had a couple years 

ago. Prices are falling. Foreclosures are up probably this year about 

50 to 75 percent over last year. So, you know, there are certainly 

some major things going on in the housing market, and they have 

created some problems in the credit markets and the rest of the 

economy as well. 

Senator CORKER. Is this the kind of thing, though, that the market can take care of itself? You know, you do not seem to have any 

other ideas legislatively that we might come forward with to deal 

with this problem. Is this something the market itself can deal 

with? 

Mr. BERNANKE. Well, the first line of defense for dealing particularly with foreclosures is to have servicers and lenders work with 

the borrowers to try to restructure their mortgages or otherwise 

find a solution. And the Treasury, the Fed and other regulators 

and the Congress certainly have encouraged the private sector to 

ramp up their efforts as much as possible to try to deal with as 

many people as possible, because there certainly is a significant increase in the number of troubled borrowers. 

I have suggested other things—and things that this Congress has 

undertaken, like FHA modernization and GSE reform—that could 

be helpful in bringing the housing market back. 

Senator CORKER. And, obviously, we have two instruments—either monetary policy or fiscal policy. You are dealing with the monetary side. I guess on our side we deal with the fiscal. 

What I am taking away from what you are saying—a very intelligent person who certainly has a much broader view of what is 

happening not only here but also in the world—is that you know 

of nothing today, you have no additional ideas legislatively or fiscally for us to deal with other than GSE reform and FHA reform. 

You know of nothing else today other than the existing efforts by 

the marketplace itself to work out some issues between lenders and 

borrowers. You know of nothing else today that we might do constructively to solve this problem. 

Mr. BERNANKE. Senator, I see no harm in trying to think about 

other alternatives, and there are things that have been suggested. 

But at this point, I am not prepared to support any additional—— 

Senator CORKER. I am all for us thinking. I am a little worried 

there is a package that is actually coming to the floor, and that 

moves something into law. But I just appreciate your testimony, 

and I want to say that just in general I do think that sometimes 

when issues occur here, our hair gets on fire to act in ways that 

I think can actually create other problems down the road. And my 

40 

sense is that what you are saying is we are doing the things that 

we know to do today that make sense. And I hope that what you 

are also saying is that before we take any other action, we will 

think about those fully and look at the long-term implications of 

the market, not just trying to deal with something in the short 

term. I think that is what—thank you, Mr. Chairman. 

Chairman DODD. Thank you very much, Senator, and I appreciate that, and I appreciate the Chairman’s response to your questions as well. And as he points out, and I pointed out, back a year 

ago we—in fact, I feel very strongly that the best line of defense 

is exactly what the Chairman has said, and that is, hopefully the 

servicers and others can work out things here so that you do not 

have to engage in extraordinary steps to try and minimize these 

problems. And that is the first line of defense, and we are very 

hopeful that will produce some results. 

I also just want to point out quickly to my good friend from Tennessee here, Residential Fixed Investment, the GDP component 

that includes spending on housing, plunged by 25.2 percent in the 

fourth quarter, a bigger drop than the earlier 23.9 percent; third 

quarter spending fell by 20.5 percent. To give you some sense of 

proportionality, that is the worst plunge since the fourth quarter 

of 1981. This is a larger issue than just a correction problem. I say 

that respectfully, but I think it is bigger than that is the case. 

Senator CORKER. If I could respond to that, I would say, too, that 

is coming off of an extreme high. I mean, we have had an exuberance in the housing market, and I think we should measure 

those drops off of a mean, if you will, versus a high. I think that 

the housing industry has enjoyed extreme free credit for many, 

many years. We have had an exuberant market that we have 

known for some time—as a matter of fact, I would say that actually 

a few years ago we were concerned in California, for instance, that 

housing prices were going up so rapidly. And so I would say that 

that drop is off an extreme high, and I thank you for pointing that 

out to me. 

Chairman DODD. Let me, if I can, Mr. Chairman, I want to raise 

a couple of questions, if I can for you, and some of them have been 

touched on. I do not want to take a long time here with you, but 

I am just intrigued by the correlation of some of these issues. 

Sometimes we cite a bunch of statistics and wonder what the correlations are between them. 

There are two factors that I want your thoughts on, if I can, that 

contribute to this huge run-up in commodity prices that we heard 

Senator Tester talk about and others. Oil is the first thing I think 

about, but obviously, if you are a farmer or a baker in Rhode Island, it can be the cost of wheat and others. The first is the increase in the demand for these goods. That is obviously one set of 

issues. The second is that these goods are priced in dollar terms. 

Sometimes we pass over that idea, but we talked about the price 

of oil a barrel, it is in dollar terms. And to what extent is the decline in the value of the dollar driving this? And beyond that concern, is that decline in the dollar—does that decline represent a decrease in confidence in the U.S. financial system? 

As the Fed report indicates—and I mentioned this at the outset—there was a net sale of U.S. securities by private foreign invesVerDate Nov 24 2008 10:00 Jul 31, 2009 Jkt 048080 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 S:\DOCS\50369.TXT JASON
41 

tors in the third quarter of 2007, the first quarterly net sale in 

more than 15 years. And I wonder how is that loss of confidence 

in the U.S. by foreign investors leading into a decline in the dollar, 

which leads to the rising commodity prices. I am trying to connect 

these questions, if at all. 

I was talking to a friend of mine in Europe this morning who is 

involved in the financial services sector—a totally different matter—and I told him I was going to be having the hearing this morning with you. And he was saying that one of the problems we have 

got is the fact that Europe is not cutting its interest rates at all, 

and so you are getting that comparison as well, which probably exacerbates this problem to some extent, at least in that market. 

And I was curious, because we have had a lot of questions of 

you—and I will come back to this in a minute—on the sovereign 

wealth funds, and I was trying to get some sense of proportionality 

about private investment versus sovereign wealth funds. And I do 

not minimize the importance of the sovereign wealth funds issues, 

but I asked staff to give me some sense of the proportionality of 

numbers. And out of the estimated $150 trillion in global capital 

stock, $2.2 trillion is held by sovereign wealth funds. And while 

sovereign wealth funds are about double the size of hedge fund assets, they represent less than 5 percent of global assets. And while 

China’s sovereign wealth fund hold is about $200 billion in assets, 

the size of China’s foreign exchange reserves is about $1.3 trillion. 

And so you have got—putting aside that for a second, the private 

investment sector here is an important one, and maybe I—am I 

making too much of this bar graph I saw in the Monetary Report 

Fund where you see for the first time that looks like a selling off 

here? And I noticed in your response to one of the—I forget who 

it was raised the question earlier. At least I thought I heard you 

say this was not as—that foreign investment is still coming in and 

that is a source of some confidence here. 

Anyway, could you try and connect those things for me? Is it a 

false connection? But I am curious how that relates to the decline 

in the dollar, the rise in commodity prices, and whether or not 

there is some connection here. 

Mr. BERNANKE. Well, I do not think that foreign investors have 

lost confidence in the United States by any means. The data you 

are referring to shows some desire by foreign investors to shift out 

of corporate credits and other credit products and into treasuries. 

That is the same shift that American investors are making. They 

are getting away from what they view as risky credits toward the 

safety of U.S. Government debt. And, indeed, U.S. Government 

debt is still the safest, most liquid, desired asset in the world. 

There is some effect of the dollar on commodities. Oil and other 

commodities are traded globally. You can think of the price as 

being set by global supply and demand. If the dollar depreciates a 

bit, then you would expect to see commodity prices rise to offset 

that depreciation. But it is important to understand that, for example, oil has risen in euros as well as in dollars. I mean, it is not 

simply an issue of currencies. It also has to do with global supply 

and demand for the commodity. So the European Central Bank is 

concerned about food and energy inflation as well. 

42 

With respect to the sovereign wealth funds, that is just another 

indication that foreigners have not lost confidence in the U.S. economy and that there has been a good bit of inflow. In particular, 

about something close to half of the capital that financial institutions have raised in the last few months has come from sovereign 

wealth funds, from other countries. 

I think that, in general, that is quite constructive. If we are confident, as I think we are in this case, that the investments are 

made for economic reasons and not for political reasons or other 

noneconomic reasons, and there is no issue of national defense, 

which the CFIUS process takes care of, then that inflow of investment is good for our economy and certainly is helping, in this case, 

the financial system. At the same time, allowing inflows of foreign 

capital through reciprocity gives us more opportunities to invest 

abroad. 

I know that Congress is very interested in sovereign wealth 

funds, and you should certainly take a close look at it. International agencies, like the International Monetary Fund and the 

OECD, are developing codes of conduct. The basic idea there is that 

sovereign wealth funds should be as transparent as possible. We 

should understand their governance and their motivations, and, in 

particular, we should be confident that they are investing, again, 

for economic rather than political or other purposes. If we are confident in that, then it is in our interest to keep our borders open 

and to allow that capital to flow in. And I think it will continue 

to flow in. 

Chairman DODD. You raise a good point here and one I wanted 

to raise with you. This is a statement you made yesterday as well 

before the House Financial Services Committee, talking about it. 

And I do not disagree. It is quite constructive. And I think there 

has to be a sense of balance in how we look at sovereign wealth 

funds, and I think we run the danger of becoming a pejorative 

without understanding the value of it. So we have to be careful 

about it. 

And you pointed out, and you did again here just now, you mentioned CFIUS, which, of course, we developed good legislation, I 

think, out of the Committee on that, the IMF, the OECD, and looking at these investments from their various perspectives in terms 

of these issues, which are a very legitimate point. 

But what is the Fed’s role in a sense? I mean, this is, it seems 

to me, while all these other institutions have an important role to 

play, I would make a case here that the Fed also has an important 

role. They are investing in bank holding companies. This is the jurisdiction of the Federal Reserve Board, and it seems to me you did 

not mention the Federal Reserve’s obligation to be looking at these 

questions as well. And, obviously, we have had major investments 

here in bank holding companies. So tell me what you think is— 

what is the Fed doing about this, and what is the responsibility of 

the Fed in looking at this issue as well? 

Mr. BERNANKE. You are quite correct, Senator. I should have 

mentioned that. 

Well, first, of course, we are very involved with the banks themselves, and we are very interested in their capital-raising efforts 

and making sure that they raise enough capital to meet the wellVerDate Nov 24 2008 10:00 Jul 31, 2009 Jkt 048080 PO 00000 Frm 00046 Fmt 6633 Sfmt 6633 S:\DOCS\50369.TXT JASON
43 

capitalized standards and to remain safe and sound. And so that 

whole process is something we pay very close attention to. 

We have statutory responsibilities. If the investment by any single person or group, whether it is a sovereign wealth fund or someone else, reaches certain levels that, imply a significant degree of 

control, then we have to look at that, make sure it is appropriate. 

Chairman DODD. Is that a sort of objective test rather than a 

subjective test? 

Mr. BERNANKE. I believe that 25 percent is the threshold. 

Chairman DODD. But I was looking and thinking—I am just curious to get your reaction to this. And, again, I do not want to overdramatize this point, but I was curious in one of these—and you 

will know which one I am talking about. One of these major investment houses, when the decision was made as to who the new CEO 

was going to be, there was a flight I think occurred that went to 

a country that was making major investment to get the OK in a 

sense. Now, the amount invested would represent an amount far 

smaller than the 25-percent threshold. But clearly, at least, if you 

will, the visuals of going over and getting sort of a sign-off indicated that there was more of an influence than the dollar amount 

would indicate. I mean, does that trigger something? Or should it 

trigger something? 

Mr. BERNANKE. Well, I think if the investor is making that big 

an investment, they need to understand what is going on. I am not 

sure whether it was a case of their deciding who was the CEO or 

just simply being informed of the plans of the company. 

In the cases that we have seen, the investments have been significant in absolute terms, but small in percentage of equity terms. 

And in most cases, the amount of control—rights, board of directors, membership and so on—has been quite limited. So there has 

not been any significant change in the control of these institutions. 

If there were, then the Federal Reserve would want to—— 

Chairman DODD. No, absolutely. I understand that. And, again, 

I am not trying to expand your portfolio here by suggesting an earlier intervention, but it would seem to me that there may be some 

signals here that may fall short of the 25 percent. I would rather 

have you taking a look at those things where—and come to me and 

say, ‘‘I think this is’’—not to me necessarily, but to say we think 

we ought to take a look at this, it may fall short of that absolute 

trigger. That is why I say objective/subjective kind of analysis as 

to what this could mean, so look at that. 

Is there any chance, any worry you have at all—coming back to 

the first question I raised with you, the declining value of the dollar, the 24-percent decline, the lowest since 1973, compared to the 

six other major currencies. Is there any chance in your mind that 

we would watch something moving away from a dollar denomination in these areas, in these commodities, such as oil going to the 

euro, for instance? Do you see any danger in that? Or is it—do you 

worry about that at all? 

Mr. BERNANKE. I know of no plans of that, but the denomination, 

as I said, is of second-order importance. There is some importance 

in the willingness of foreigners to hold dollar assets, which is a different matter entirely. And as I said, I know of no evidence that 

there is any reduction in interest. 

44 

Chairman DODD. Would that concern you if that happened? I 

mean, is there—— 

Mr. BERNANKE. If there was a change in denomination? 

Chairman DODD. Yes, if they moved all of a sudden, went from 

the price of a barrel of oil measured not in dollars but in euros, 

what does that say about us and our economy? Does that have— 

I mean, it seems to me that would be rather a dramatic piece of 

news. 

Mr. BERNANKE. Well, it might be symbolic. It might have symbolic value. But from an economic point of view, it is a global market, and foreign currencies are traded all the time. You know, if I 

want to buy a barrel of oil, I can do it in euro or yen or any other 

way I like. So from a fundamental sense point of view, it is not significant. There might be some symbolic value to it if that happened. 

Chairman DODD. I was going to ask you a question to follow up 

on Senator Menendez who asked questions about the housing 

issue. But I think your answers in response to Senator Corker were 

good ones in thinking about this issue. And I sense in your comments here today that this housing issue is a serious one. And I 

am not going to try and put words in your mouth again, but I realize you put an adjective on this, and that becomes the headline. 

But it is serious and warrants serious thought as to what we can 

do to minimize this and to try and keep people in their homes, minimize this from happening again, and dealing with related issues. 

And I appreciate those comments. And we are going to continue 

talking with you about these various ideas that we have. And I certainly appreciate, having been here long enough to know, that 

sometimes actions, however well intended, can have unintended 

consequences, and so you need to think through things carefully. 

And so we are going to want to be in touch with you during that 

process. 

But we also want to make sure we are not looking back and wondering if we could have done some things here that would have 

minimized this from getting worse. So it is important. 

I will leave the record open for a couple of days here. Members 

who did not make it here may have some additional questions for 

you. You have been before this Committee a lot now in the last couple of weeks, and we are grateful to you for that, and we will continue working with you. 

The Committee will stand adjourned. 

[Whereupon, at 12:32 p.m., the hearing was adjourned.] 

[Prepared statements, response to written questions, and additional material supplied for the record follow:] 

45 

PREPARED STATEMENT OF SENATOR JIM BUNNING 

Thank you, Mr. Chairman. 

The health of our economy and financial markets is a concern to everyone here 

today. Growth has slowed and we have been through a rough patch in the credit 

markets. Everyone wants to see stability and growth return. Congress has acted to 

restore confidence in the economy. The Fed has taken steps to thaw the credit 

freeze. We hope that these policy actions will head off further damage, but no policy 

can reverse the busting of the housing bubble and we are not going to regulate away 

problems in the economy. 

While I have supported actions taken to respond to our economic problems, I fear 

they will have unintended consequences. I am most concerned about inflation and 

the fall of the dollar. We need to think beyond what we have already done and take 

steps to encourage long term growth. Congress can give taxpayers, businesses, and 

investors certainty that their taxes are not going to go up. Congress can knock down 

roadblocks to growth such as artificial limits on our energy supply. Congress can 

make it more appealing for corporations to stay in the United States by easing regulations and lowering the corporate tax rate. Only with long term permanent policies 

can we ensure a healthy economy for our grandchildren. 

I look forward to hearing from the Chairman. 

PREPARED STATEMENT OF SENATOR ELIZABETH DOLE 

Thank you, Chairman Dodd and Ranking Member Shelby for holding this very 

important hearing today. Chairman Bernanke, I join my colleagues in extending you 

a warm welcome. 

Since last August, our financial markets have experienced tremendous uncertainty. Credit and capital markets around the world have struggled to comprehend 

the ramifications of the U.S. subprime lending and housing crisis. Fortunately, the 

Federal Reserve has been quick to act, lowering the federal funds rate from 5.25 

percent to 3 percent. Congress also is working to help boost our economy. 

Several recent reports have highlighted ongoing economic challenges. Such as last 

week, the Wall Street Journal said that the ‘‘leading economic indicators’’ fell for 

the fourth straight month. Since its July 2007 high, the index has fallen by 2 percent, which is the largest 6-month drop since 2001. Additionally, for the week ending on February 16, the 4-week average of initial unemployment claims rose by 

10,750 to 360,500, pointing to a softening of the labor market. 

Furthermore, by the third quarter of 2007, household debt rose to $13.6 trillion 

from $7.2 trillion in 2001, a 10-percent annual increase. Over this same time period, 

mortgage borrowing more than doubled. As a result, one out of every seven dollars 

of disposable income earned by Americans goes towards paying down debt. 

Fears loom of higher inflation and more ‘‘pain at the pump.’’ The price of a barrel 

of oil has hovered around the $90 mark and recently closed above $100 per barrel. 

If these higher gas prices and inflationary pressures continue, coupled with the 

well-known weakness in across our housing sector, I—like many folks I hear from— 

am very concerned that future economic growth could be hindered. 

No question, the health of our economy is influenced by many complex issues and 

expected and unexpected events. That said, I would like to highlight a few areas 

where I am focused to help spur growth and job creation. 

I strongly support Trade Adjustment Assistance, which helps ensure that displaced workers have the ability to train for new careers. In recent years, my home 

state of North Carolina has undergone a difficult economic transition, as our state 

continues to evolve from a manufacturing and agriculture-based economy to a more 

services-oriented economy. In North Carolina and across the country, there is a need 

to address the growing gap between skilled and unskilled workers. Senator Cantwell 

and I have introduced legislation that would allow more workers to receive TAA 

benefits, including training, job search and relocation allowances, income support 

and other reemployment services. 

Additionally, with respect to current regulation of financial institutions, it has 

come to my attention that some smaller banks are overburdened by compliance with 

Sections 404 and 302 of the Sarbanes-Oxley corporate accountability law. Mr. Chairman, these financial institutions are already highly-regulated, and it has become increasingly apparent that these regulations, while well-intended, only increase their 

costs of doing business. I hope this committee will soon consider legislation that 

would provide true regulatory relief for all financial institutions. 

Chairman Bernanke, thank you again for being here today. I look forward to hearing from you—and working with you—on these and other important issues. 

46 

PREPARED STATEMENT OF BEN S. BERNANKE 

CHAIRMAN, 

BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM

FEBRUARY 28, 2008 

Chairman Dodd, Ranking Member Shelby, and other Members of the Committee, 

I am pleased to present the Federal Reserve’s Monetary Policy Report to the Congress. In my testimony this morning I will briefly review the economic situation and 

outlook, beginning with developments in real activity and inflation, then turn to 

monetary policy. I will conclude with a quick update on the Federal Reserve’s recent 

actions to help protect consumers in their financial dealings. 

The economic situation has become distinctly less favorable since the time of our 

July report. Strains in financial markets, which first became evident late last summer, have persisted; and pressures on bank capital and the continued poor functioning of markets for securitized credit have led to tighter credit conditions for 

many households and businesses. The growth of real gross domestic product (GDP) 

held up well through the third quarter despite the financial turmoil, but it has since 

slowed sharply. Labor market conditions have similarly softened, as job creation has 

slowed and the unemployment rate—at 4.9 percent in January—has moved up 

somewhat. 

Many of the challenges now facing our economy stem from the continuing contraction of the U.S. housing market. In 2006, after a multiyear boom in residential construction and house prices, the housing market reversed course. Housing starts and 

sales of new homes are now less than half of their respective peaks, and house 

prices have flattened or declined in most areas. Changes in the availability of mortgage credit amplified the swings in the housing market. During the housing sector’s 

expansion phase, increasingly lax lending standards, particularly in the subprime 

market, raised the effective demand for housing, pushing up prices and stimulating 

construction activity. As the housing market began to turn down, however, the 

slump in subprime mortgage originations, together with a more general tightening 

of credit conditions, has served to increase the severity of the downturn. Weaker 

house prices in turn have contributed to the deterioration in the performance of 

mortgage-related securities and reduced the availability of mortgage credit. 

The housing market is expected to continue to weigh on economic activity in coming quarters. Homebuilders, still faced with abnormally high inventories of unsold 

homes, are likely to cut the pace of their building activity further, which will subtract from overall growth and reduce employment in residential construction and 

closely related industries. 

Consumer spending continued to increase at a solid pace through much of the second half of 2007, despite the problems in the housing market, but it appears to have 

slowed significantly toward the end of the year. The jump in the price of imported 

energy, which eroded real incomes and wages, likely contributed to the slowdown 

in spending, as did the declines in household wealth associated with the weakness 

in house prices and equity prices. Slowing job creation is yet another potential drag 

on household spending, as gains in payroll employment averaged little more than 

40,000 per month during the 3 months ending in January, compared with an average increase of almost 100,000 per month over the previous 3 months. However, the 

recently enacted fiscal stimulus package should provide some support for household 

spending during the second half of this year and into next year. 

The business sector has also displayed signs of being affected by the difficulties 

in the housing and credit markets. Reflecting a downshift in the growth of final demand and tighter credit conditions for some firms, available indicators suggest that 

investment in equipment and software will be subdued during the first half of 2008. 

Likewise, after growing robustly through much of 2007, nonresidential construction 

is likely to decelerate sharply in coming quarters as business activity slows and 

funding becomes harder to obtain, especially for more speculative projects. On a 

more encouraging note, we see few signs of any serious imbalances in business inventories aside from the overhang of unsold homes. And, as a whole, the nonfinancial business sector remains in good financial condition, with strong profits, liquid balance sheets, and corporate leverage near historical lows. 

In addition, the vigor of the global economy has offset some of the weakening of 

domestic demand. U.S. real exports of goods and services increased at an annual 

rate of about 11 percent in the second half of last year, boosted by continuing economic growth abroad and the lower foreign exchange value of the dollar. Strengthening exports, together with moderating imports, have in turn led to some improvement in the U.S. current account deficit, which likely narrowed in 2007 (on an annual basis) for the first time since 2001. Although recent indicators point to some 

47 

slowing of foreign economic growth, U.S. exports should continue to expand at a 

healthy pace in coming quarters, providing some impetus to domestic economic activity and employment. 

As I have mentioned, financial markets continue to be under considerable stress. 

Heightened investor concerns about the credit quality of mortgages, especially 

subprime mortgages with adjustable interest rates, triggered the financial turmoil. 

However, other factors, including a broader retrenchment in the willingness of investors to bear risk, difficulties in valuing complex or illiquid financial products, uncertainties about the exposures of major financial institutions to credit losses, and 

concerns about the weaker outlook for economic growth, have also roiled the financial markets in recent months. To help relieve the pressures in the market for interbank lending, the Federal Reserve—among other actions—recently introduced a 

term auction facility (TAF), through which prespecified amounts of discount window 

credit are auctioned to eligible borrowers, and we have been working with other central banks to address market strains that could hamper the achievement of our 

broader economic objectives. These efforts appear to have contributed to some improvement in short-term funding markets. We will continue to monitor financial developments closely. 

As part of its ongoing commitment to improving the accountability and public understanding of monetary policy making, the Federal Open Market Committee 

(FOMC) recently increased the frequency and expanded the content of the economic 

projections made by Federal Reserve Board members and Reserve Bank presidents 

and released to the public. The latest economic projections, which were submitted 

in conjunction with the FOMC meeting at the end of January and which are based 

on each participant’s assessment of appropriate monetary policy, show that real 

GDP was expected to grow only sluggishly in the next few quarters and that the 

unemployment rate was seen as likely to increase somewhat. In particular, the central tendency of the projections was for real GDP to grow between 1.3 percent and 

2.0 percent in 2008, down from 21⁄2 percent to 23⁄4 percent projected in our report 

last July. FOMC participants’ projections for the unemployment rate in the fourth 

quarter of 2008 have a central tendency of 5.2 percent to 5.3 percent, up from the 

level of about 43⁄4 percent projected last July for the same period. The downgrade 

in our projections for economic activity in 2008 since our report last July reflects 

the effects of the financial turmoil on real activity and a housing contraction that 

has been more severe than previously expected. By 2010, our most recent projections show output growth picking up to rates close to or a little above its longerterm trend and the unemployment rate edging lower; the improvement reflects the 

effects of policy stimulus and an anticipated moderation of the contraction in housing and the strains in financial and credit markets. The incoming information since 

our January meeting continues to suggest sluggish economic activity in the near 

term. 

The risks to this outlook remain to the downside. The risks include the possibilities that the housing market or labor market may deteriorate more than is currently anticipated and that credit conditions may tighten substantially further. 

Consumer price inflation has increased since our previous report, in substantial 

part because of the steep run-up in the price of oil. Last year, food prices also increased significantly, and the dollar depreciated. Reflecting these influences, the 

price index for personal consumption expenditures (PCE) increased 3.4 percent over 

the four quarters of 2007, up from 1.9 percent in 2006. Core price inflation—that 

is, inflation excluding food and energy prices—also firmed toward the end of the 

year. The higher recent readings likely reflected some pass-through of energy costs 

to the prices of core consumer goods and services as well as the effect of the depreciation of the dollar on import prices. Moreover, core inflation in the first half of 

2007 was damped by a number of transitory factors—notably, unusually soft prices 

for apparel and for financial services—which subsequently reversed. For the year as 

a whole, however, core PCE prices increased 2.1 percent, down slightly from 2006. 

The projections recently submitted by FOMC participants indicate that overall 

PCE inflation was expected to moderate significantly in 2008, to between 2.1 percent and 2.4 percent (the central tendency of the projections). A key assumption underlying those projections was that energy and food prices would begin to flatten 

out, as was implied by quotes on futures markets. In addition, diminishing pressure 

on resources is also consistent with the projected slowing in inflation. The central 

tendency of the projections for core PCE inflation in 2008, at 2.0 percent to 2.2 percent, was a bit higher than in our July report, largely because of some higher-thanexpected recent readings on prices. Beyond 2008, both overall and core inflation 

were projected to edge lower, as participants expected inflation expectations to remain reasonably well-anchored and pressures on resource utilization to be muted. 

The inflation projections submitted by FOMC participants for 2010—which ranged 

48 

from 1.5 percent to 2.0 percent for overall PCE inflation—were importantly influenced by participants’ judgments about the measured rates of inflation consistent 

with the Federal Reserve’s dual mandate and about the time frame over which policy should aim to attain those rates. 

The rate of inflation that is actually realized will of course depend on a variety 

of factors. Inflation could be lower than we anticipate if slower-than-expected global 

growth moderates the pressure on the prices of energy and other commodities or if 

rates of domestic resource utilization fall more than we currently expect. Upside 

risks to the inflation projection are also present, however, including the possibilities 

that energy and food prices do not flatten out or that the pass-through to core prices 

from higher commodity prices and from the weaker dollar may be greater than we 

anticipate. Indeed, the further increases in the prices of energy and other commodities in recent weeks, together with the latest data on consumer prices, suggest 

slightly greater upside risks to the projections of both overall and core inflation than 

we saw last month. Should high rates of overall inflation persist, the possibility also 

exists that inflation expectations could become less well anchored. Any tendency of 

inflation expectations to become unmoored or for the Fed’s inflation-fighting credibility to be eroded could greatly complicate the task of sustaining price stability and 

could reduce the flexibility of the FOMC to counter shortfalls in growth in the future. Accordingly, in the months ahead, the Federal Reserve will continue to monitor closely inflation and inflation expectations. 

Let me turn now to the implications of these developments for monetary policy. 

The FOMC has responded aggressively to the weaker outlook for economic activity, 

having reduced its target for the federal funds rate by 225 basis points since last 

summer. As the Committee noted in its most recent post-meeting statement, the intent of those actions has been to help promote moderate growth over time and to 

mitigate the risks to economic activity. 

A critical task for the Federal Reserve over the course of this year will be to assess whether the stance of monetary policy is properly calibrated to foster our mandated objectives of maximum employment and price stability in an environment of 

downside risks to growth, stressed financial conditions, and inflation pressures. In 

particular, the FOMC will need to judge whether the policy actions taken thus far 

are having their intended effects. Monetary policy works with a lag. Therefore, our 

policy stance must be determined in light of the medium-term forecast for real activity and inflation as well as the risks to that forecast. Although the FOMC participants’ economic projections envision an improving economic picture, it is important 

to recognize that downside risks to growth remain. The FOMC will be carefully evaluating incoming information bearing on the economic outlook and will act in a timely manner as needed to support growth and to provide adequate insurance against 

downside risks. 

Finally, I would like to say a few words about the Federal Reserve’s recent actions 

to protect consumers in their financial transactions. In December, following up on 

a commitment I made at the time of our report last July, the Board issued for public 

comment a comprehensive set of new regulations to prohibit unfair or deceptive 

practices in the mortgage market, under the authority granted us by the Home 

Ownership and Equity Protection Act of 1994. The proposed rules would apply to 

all mortgage lenders and would establish lending standards to help ensure that consumers who seek mortgage credit receive loans whose terms are clearly disclosed 

and that can reasonably be expected to be repaid. Accordingly, the rules would prohibit lenders from engaging in a pattern or practice of making higher-priced mortgage loans without due regard to consumers’ ability to make the scheduled payments. In each case, a lender making a higher priced loan would have to use thirdparty documents to verify the income relied on to make the credit decision. For 

higher-priced loans, the proposed rules would require the lender to establish an escrow account for the payment of property taxes and homeowners’ insurance and 

would prevent the use of prepayment penalties in circumstances where they might 

trap borrowers in unaffordable loans. In addition, for all mortgage loans, our proposal addresses misleading and deceptive advertising practices, requires borrowers 

and brokers to agree in advance on the maximum fee that the broker may receive, 

bans certain practices by servicers that harm borrowers, and prohibits coercion of 

appraisers by lenders. We expect substantial public comment on our proposal, and 

we will carefully consider all information and viewpoints while moving expeditiously 

to adopt final rules. 

The effectiveness of the new regulations, however, will depend critically on strong 

enforcement. To that end, in conjunction with other federal and state agencies, we 

are conducting compliance reviews of a range of mortgage lenders, including nondepository lenders. The agencies will collaborate in determining the lessons learned 

49 

and in seeking ways to better cooperate in ensuring effective and consistent examinations of, and improved enforcement for, all categories of mortgage lenders. 

The Federal Reserve continues to work with financial institutions, public officials, 

and community groups around the country to help homeowners avoid foreclosures. 

We have called on mortgage lenders and servicers to pursue prudent loan workouts 

and have supported the development of streamlined, systematic approaches to expedite the loan modification process. We also have been providing community groups, 

counseling agencies, regulators, and others with detailed analyses to help identify 

neighborhoods at high risk from foreclosures so that local outreach efforts to help 

troubled borrowers can be as focused and effective as possible. We are actively pursuing other ways to leverage the Federal Reserve’s analytical resources, regional 

presence, and community connections to address this critical issue. 

In addition to our consumer protection efforts in the mortgage area, we are working toward finalizing rules under the Truth in Lending Act that will require new, 

more informative, and consumer-tested disclosures by credit card issuers. Separately, we are actively reviewing potentially unfair and deceptive practices by 

issuers of credit cards. Using the Board’s authority under the Federal Trade Commission Act, we expect to issue proposed rules regarding these practices this spring. 

Thank you. I would be pleased to take your questions. 

50 

RESPONSE TO WRITTEN QUESTIONS OF SENATOR SHELBY 

FROM BEN S. BERNANKE 

Q.1. Increases in the GSE/FHA Conforming Loan Limits: The stimulus bill recently passed by Congress includes an increase in the 

conforming loan limit amount for mortgages that the Government 

Sponsored Entities (GSEs) and the Federal Housing Administration can guarantee. 

Do you believe that increasing these loan amounts adds to the 

systemic risks associated with the GSEs’ operations? 

While these increases are only temporary, some have raised the 

idea of permanently increasing the amounts. Are there additional 

risks associated with a permanent increase? 

A.1. Temporarily raising the conforming loan limit allows the GSEs 

to securitize an expanded range of mortgage loans and likely would 

increase liquidity in the secondary market for loans covered by the 

expansion. The GSEs should be strongly encouraged to rapidly use 

this authority, even if it requires that they raise substantial 

amounts of capital. 

Over a longer horizon, it is important to realize that raising the 

conforming loan limits extends the implicit government-backing of 

the GSEs into a larger portion of the mortgage market. While the 

jumbo mortgage market has experienced substantial liquidity problems during the past year, this market historically has operated efficiently and functioned well without GSE involvement. Moreover, 

prime quality homeowners who use jumbo mortgages are, in general, the highest income and wealthiest members of our society. Extending the reach of the GSEs to these borrowers would do little 

to expand homeownership or to extend mortgage credit to those 

that cannot obtain mortgages otherwise. 

Thus, raising the conforming loan limit involves the larger question of how far to extend government guarantees, either explicit or 

implicit, to resolve short-term liquidity problems in secondary asset 

markets. Temporary expansions of the safety net, such as those undertaken by the Federal Reserve, can boost short-term liquidity 

without distorting private market credit analysis. In contrast, permanent expansions of the safety net, such as raising the conforming loan limit permanently, may well cause greater problems 

in the long-run. There are many reasons for the recent breakdown 

in private market credit analysis, but it is not clear to me that the 

best approach to rectify the current situation is simply to substitute implicit government guarantees for much needed private 

market discipline. If private markets are unable to provide a secondary market for some assets, we should first endeavor to understand why this is the case rather than immediately turn to a 

broader expansion of GSE guarantees. 

Any permanent expansion of GSE guarantees must, be accompanied by comprehensive GSE reform to mitigate further systemic 

risks. In particular, capital standards for the GSEs must be significantly toughened and clear and credible receivership procedures for 

the GSEs should be established. Moreover, the role and function of 

the GSE portfolios should be clearly articulated by Congress. As 

has been evident in recent months, this portfolio is managed mainly to meet needs of GSE shareholders and not to fulfill public policy 

objectives. 

51 

Q.2. International Liquidity Coordination: Chairman Bernanke, as 

of the minutes of the last Federal Open Market Committee meeting, the Federal Reserve reaffirmed their commitment to working 

with foreign central banks to coordinate international monetary 

policy. 

Please describe for us the details of the Federal Reserve’s agreements with foreign central banks, such as the European Central 

Bank and the Bank of England for exchanging assets into dollars. 

Why have these agreements been made and are financial institutions using these tools? 

A.2. The Federal Open Market Committee (FOMC) established 

swap lines with the European Central Bank (ECB)and Swiss National Bank (SNB) in conjunction with the establishment of the 

Term Auction Facility (TAF) on December 12, 2007. These swap 

agreements were requested by the ECB and SNB and allowed them 

to draw a maximum of $20 billion and $4 billion respectively, for 

a period of up to 6 months. Under the agreements, both central 

banks are allowed to purchase U.S. dollars with their foreign currencies based on the prevailing spot exchange rate, and they pay 

interest on the foreign currency received by the Federal Reserve. 

Given the strong financial position of the ECB and SNB, the swap 

lies involve virtually no credit risk to the Federal Reserve. The 

Federal Reserve has also maintained longstanding swap facilities 

with the Bank of Mexico and the Bank of Canada as part of the 

North American Framework Agreement. Those facilities amount to 

$2 billion with the Bank of Canada and $3 billion with the Bank 

of Mexico. 

The agreements with the ECB and SNB were established to 

allow dollar funding problems faced by European and Swiss banks 

to be addressed directly by their respective home central banks. In 

the absence of such agreements, European and Swiss banks were 

believed to be more likely to seek dollar funding in U.S. markets, 

potentially increasing volatility and adding to term funding pressures in U.S. markets. By providing dollars to the ECB and SNB 

to use in their efforts to address term dollar funding problems 

abroad, the FOMC believed that it would assist U.S. credit markets. 

Both the ECB and SNB have used their swap agreements. The 

first use of these swap lines was on Monday, December 17, when 

the ECB drew upon $10 billion and the SNB drew upon $4 billion 

for a 28-day period. The two central banks used the funds to auction dollar funding to their eligible depository institutions; the ECB 

offered funds to its eligible depository institutions at the 4.65 percent rate set in the Federal Reserve’s TAF auction, and the SNB 

auctioned $4 billion at a weighted average rate of 4.79 percent. The 

ECB drew upon a further $10 billion on Thursday, December 20, 

in conjunction with the second TAF auction held by the Federal Reserve. At the expiration of its first use of its swap line, the ECB 

renewed its draws in conjunction with the January 14 and January 

28 TAF auctions, offering $10 billion in 28-day dollar funds both 

times at a rate equal to the rate set in the TAF auction. The SNB 

also renewed its draw of $4 billion on its swap line to participate 

in the January 14 auction of dollar funds. On March 11, the FOMC 

announced that it would increase its temporary swap line to the 

52 

ECB from $20 billion to $30 billion and its line to the SNB from 

$4 billion to $6 billion, extending the swap lines through September 30, 2008. Both central banks have signaled that they would 

draw upon the lines to offer 28-day dollar funding in auctions to 

be held on March 25. 

Q.3. Sovereign Wealth Funds and Systemic Risk: Chairman 

Bernanke, recently we have seen an influx of capital into our domestic financial institutions from foreign governments, specifically 

sovereign wealth funds. Previous foreign direct investments have 

usually been in smaller quantities and from private investors, rather than governments. These investments may be under the threshold of control for each sale, but collectively could represent a large 

proportion of U.S. financial services firms. 

Is there a danger of systemic risk from one or more Sovereign 

Wealth Funds holding noncontrolling stakes many financial firms? 

A.3. The recent prominent equity investments by sovereign wealth 

funds in large U.S. financial institutions permanently increased the 

capital of these firms, enhancing their soundness and the soundness of the U.S. financial system. These investments also support 

the ability of the financial institutions to provide credit to businesses and consumers. It is difficult to envision circumstances 

under which non-controlling equity stakes in financial institutions, 

could increase systemic risk in a financial system. 

Sovereign wealth funds have been relatively stable investors. The 

funds generally are neither highly leveraged nor exposed to liquidity risk arising from investor withdrawals or redemptions. Sovereign wealth funds often use professional private fund managers 

who are tasked with seeking higher returns and greater diversification—relative to official reserves—for a portion of a country’s foreign exchange assets. 

Because sovereign wealth funds are government owned, there 

has been concern, however, that these funds have the potential to 

be motivated by political reasons To the extent these funds make 

only smaller, noncontrolling investments, the ability of a sovereign 

wealth fund to have an effect on the operation, strategic direction 

or policies of a banking organization are minimal. 

If two or more companies with noncontrolling investments in a 

U.S. bank or bank holding company were to agree to act together 

in an attempt to influence the operations of a U.S. bank or bank 

holding company, the Federal Reserve has the authority to combine 

the companies’ shareholdings and treat the group as one company 

(an ‘‘association’’) for purposes of the Bank Holding Company Act 

(BHC Act). If the combined shareholding were significant enough, 

the association could be treated as a bank holding company subject 

to the requirements of the BHC Act. To date, the Board has not 

found that sovereign wealth funds from different countries have in 

fact acted together to control a U.S. financial institution. 

Another important safeguard applies to the U.S. banking organization itself. U.S. banking organizations themselves are subject to 

the supervisory and regulatory requirements of U.S. banking law. 

For example, federal banking agencies are required under the Federal Deposit Insurance Act to establish certain safety and soundness standards by regulation or guideline for all U.S. insured deVerDate Nov 24 2008 10:00 Jul 31, 2009 Jkt 048080 PO 00000 Frm 00056 Fmt 6602 Sfmt 6602 S:\DOCS\50369.TXT JASON
53 

pository institutions. These standards are designed to identify potential safety and soundness concerns and ensure that action is 

taken to address those concerns before they pose a risk to the Deposit Insurance Fund. Thus, the Federal banking agencies may 

monitor and require action by the U.S. banking organization to 

maintain its financial health regardless of the owner of the banking organization. 

Q.4. Is there a Bernanke ‘‘Put’’? Chairman Bernanke, some economists speculate that market participants became willing to take 

greater risks because monetary policy under Chairman Greenspan 

protected investments by cutting interest rates in response to economic shocks. This phenomenon came to be called the Greenspan 

‘‘put’’—referring to the financial instrument that guarantees its 

owner a certain return if prices fall below a specified level. Now 

critics are wondering if there is also a Bernanke put, given the recent significant drop in rates. 

How do you respond to these observations? How do you balance 

responding to slower economic growth while at the same time allowing the market to follow a normal business cycle? 

Do you have any concerns that the 225 basis point drop in interest rates since last August creates moral hazard for market participants? 

A.4. In conducting monetary policy, the Federal Reserve is guided 

by its statutory mandate to promote maximum employment and 

stable prices over time. I do not believe that monetary policy actions aimed at these goals are a significant source of moral hazard. 

To be sure, in carrying out its mandate, the Federal Reserve takes 

account of a broad range of factors that influence the outlook for 

economic growth and inflation, importantly including financial 

asset prices, such as the prices of equity shares and houses. Financial asset prices are important for the economic outlook partly because they affect household wealth and thus consumer spending on 

goods and services and therefore ultimately influence output, employment, and inflationary pressures. Depending on overall circumstances, declines in asset prices may adversely affect the outlook for aggregate demand, and consequently the stance of monetary policy may need to be eased in order to cushion the effect on 

aggregate demand. It is important to recognize that such a response of monetary policy is not designed to support financial asset 

prices themselves but to foster overall economic growth and to mitigate the risks of particularly adverse economic outcomes. It is also 

worth noting that past Federal Reserve efforts to buoy economic 

growth in the face of declining asset prices have not insulated from 

substantial losses investors who made poor investment choices. 

This point is evidenced by the very large losses suffered by investors in the tech sector early this decade despite considerable monetary policy easing, and by the losses experienced by investors in 

many subprime-related mortgage products more recently even as 

the stance of monetary policy was eased. 

Q.5. Term Auction Facility: Chairman Bernanke, the Federal Reserve created a new Term Auction Facility to help ensure that 

American banks have adequate liquidity. 

54 

What has been the response to the auctions thus far and for how 

long will they continue? 

What type of collateral are banks posting in these auctions? 

What happens if that collateral, particularly AAA-rated mortgage 

backed securities, is downgraded? 

A.5. The demand for TAF credit from depository institutions has 

been ample. All eight auctions conducted to date have been oversubscribed, with resulting interest rates in each case above the 

minimum bid rate. The Federal Reserve will continue to conduct 

TAF auctions for at least the next 6 months unless evolving market 

conditions clearly indicate that such auctions are no longer necessary. 

TAF borrowing is collateralized by the same pool of assets as 

pledged against other types of discount window loans. For all types 

of discount window loans, Federal Reserve Banks will consider accepting as collateral any assets that meet regulatory standards for 

sound asset quality. Commonly pledged assets include residential 

and commercial real estate loans, consumer loans, business loans, 

and a variety of securities. The standards applied to each type of 

collateral are available on the Federal Reserve discount window 

Web site at www.frbdiscountwindow.erg. Collateral that is downgraded below Federal Reserve eligibility standards is given no 

value and must be withdrawn. The likelihood that the downgrade 

of a portion of a depository institution’s collateral will affect a TAF 

loan is reduced by the requirement that, at the time of bidding, the 

sum of the aggregate bid amount submitted by a depository institution and the principal amount of TAF advances that the same depository institution may have outstanding cannot exceed 50 percent 

of the collateral value of the assets pledged by the depository institution. 

Q.6. Value of the Dollar: As you know, the U.S. dollar declined 

against most major currencies over the past year. The dollar has 

lost 10.4 percent again the Euro and 5.7 percent versus the yen in 

2007. 

What does it mean for our economy if foreign countries turn 

away from holding the dollar as their reserve currency or even if 

they diversify, which has already begun? 

Are there dangers that we will be more constrained in the actions we are able to take domestically, including selling Treasury 

securities, to finance our deficit? 

A.6. The dollar’s status as a reserve currency reflects investor confidence in the sophistication and liquidity of U.S. financial markets 

and the relative stability of our macroeconomic environment. To 

date, there is little evidence of a shift in foreign official holdings 

away from dollar denominated assets. U.S. data show further 

growth in foreign official holdings of U.S. assets. Data reported to 

the IMF also show continued growth in dollar assets in foreign official reserves. While the IMF data show a decline in the dollar 

share of reported reserves, this decline is entirely attributable to 

the depreciation of the dollar, which has raised the dollar value of 

the other currencies held in the reserve portfolios. In response to 

a private survey conducted by the Royal Bank of Scotland, several 

reserve managers indicated they planned to increase the weight of 

55 

non-dollar assets in future investments, but there was again no 

evidence of a general shift out of the dollar on the part of these respondents. 

In principle, a shift in foreign appetite away from U.S. securities 

toward foreign securities might be expected to lower the value of 

the dollar and to raise U.S. interest rates; however, these effects 

are difficult to measure and appear to be modest. Furthermore, 

while it is true that foreign official institutions hold a significant 

fraction of U.S. Treasury securities outstanding, it is important to 

note that these holdings represent less than 5 percent of the total 

debt outstanding in U.S. credit markets. As such, U.S. credit markets could likely absorb a shift in foreign official allocations away 

from dollar assets without undue difficulty. In the event that such 

a shift were to occur and put undesired upward pressure on U.S. 

interest rates, the Federal Reserve has the capacity to increase 

available credit to maintain a level of short-term interest rates consistent with our domestic economic goals. Any effect of reduced foreign demand on the term premium between short-term and longterm interest rates could affect the cost of long-term borrowing by 

the Federal Government; however, this impact is likely to be relatively small and is unlikely to materially constrain the U.S. government’s ability to finance its deficit. 

Q.7. Slow Growth and Rising Inflation: Mr. Chairman, there is 

some evidence of contradictory forces at play in the economy right 

now. In the middle of the present economic downturn, commodity 

and food prices have increased. 

What do you judge to be the threat of slow growth continuing, 

with inflation remaining above the Federal Reserve’s comfort level? 

A.7. The FOMC, in the statement released at the conclusion of its 

most recent meeting on March 18, noted that the outlook for economic activity has weakened further in recent weeks and that 

downside risks to growth remain. At the same time, inflation has 

been elevated, uncertainty about the inflation outlook has increased The actions taken by the Federal Reserve since last August, including measures to foster market liquidity, should help to 

promote moderate growth over time and to mitigate the risks to 

economic activity. However, the Federal Reserve remains attentive 

to the risks to the outlook for activity and inflation, and it will act 

in a timely manner as needed to promote sustainable economic 

growth and price stability. 

Q.8. Capital: The ongoing turmoil in our financial markets vividly 

demonstrates the wisdom of prudent capital requirements for our 

financial institutions. If our financial institutions hold sufficient 

capital, they are much more likely to weather the inevitable economic storms that occur as part of the business cycle. Because a 

healthy banking system is one of the best defenses against a severe 

economic downturn, one of the most important responsibilities of 

our financial regulators is ensuring that financial institutions are 

adequately capitalized. 

Chairman Bernanke, what is your assessment of the current capital levels in our banking system? As part of your answer, would 

you explain the steps your agency has taken over the past year to 

make sure that our banks are adequately capitalized? 

56 

A.8. As you how a bank is deemed to be well capitalized under 

Prompt Corrective Action rules if it has a tier 1 risk-based capital 

ratio of 6 percent or greater, a total risk-based capital ratio of 10 

percent or greater, a leverage ratio of 5 percent or greater and is 

not subject to any written directive issued by the Federal Reserve 

Board. As can be seen in the summary table below, the majority 

of U.S. commercial banks have substantial buffers over the well 

capitalized requirements (as of year-end 2007), which should prove 

helpful during these difficult times. However, capital ratios in 

banking organizations can erode rapidly during downturns, depending on the rate of increase and amounts of write-downs and 

additions to the allowance for losses and the extent to which these 

cannot be offset by the retention of earnings or raising of new capital. 

Summary Average Data for Insured Commercial Banks 

Ratios Avg. 1997–2007 2006 2007 

Equity Capital/Assets ...................................................................................................... 9.2 10.2 10.2 

Leverage .......................................................................................................................... 7.8 8.1 7.9 

Tier 1 Ratio (Risk-Based) ............................................................................................... 9.7 9.8 9.4 

Total Ratio (Risk-Based) ................................................................................................ 12.4 12.4 12.2 

% Deemed Well Capitalized ........................................................................................... 98.3 99.3 98.9 

Source: Summary Profile Report, Dec. 2007, BS&R, Federal Reserve Board of Governors. 

The Federal Reserve Board, together with the other banking 

agencies, is currently reviewing several elements of its regulatory 

capital requirements to ensure that banking organizations have 

sufficient capital levels to weather losses during difficult times and 

to ensure a high standard in the quality of capital (i.e., its ability 

to absorb losses effectively) being issued by these organizations. In 

addition, our ongoing supervisory activities include monitoring 

banking organizations’ asset quality, market exposures, quality of 

earnings, capital management plans, effectiveness and adequacy of 

provisioning, and valuation policies, all of which directly impact the 

banking organizations’ capital standing. 

In December 2007, the Federal Reserve Board, together with the 

other banking agencies, approved final rules implementing the 

Basel II advanced risk-based capital rules—for large, internationally active banking organizations—that more closely align regulatory capital requirements with actual risks and should further 

strengthen banking organizations’ risk-management practices. The 

improvements in risk management under Basel II will be valuable 

in promoting the resiliency of the banking and financial systems. 

Under the Basel II rules, banking organizations must have rigorous processes for assessing their overall capital adequacy in relation to their total risk profile and publicly disclose information 

about their risk profile and capital adequacy. We will continue to 

assess the Federal Reserve Board’s capital rules to ensure that 

banking organizations’ capital requirements remain prudent. 

Q.9. Role of Credit Rating Agencies for Capital Requirements: 

Many financial institutions and pension funds are only permitted 

to hold assets with an ‘‘investment grade’’ rating. 

Chairman Bernanke, what steps is the Fed taking to ensure that 

banks monitor the quality of assets on their balance sheets and 

57 

1Senior Supervisors’ Group, ‘‘Observations on Risk Management Practices During the Recent 

Market Turbulence,’’ March 6, 2008. 2The President’s Working group on Financial Markets, ‘‘Policy Statement on Financial Market Developments,’’ March 12, 2008. 

that financial institutions are not outsourcing their due diligence 

requirements to credit rating agencies? 

A.9. Many investors and financial firms relied too heavily on ratings assigned by credit rating agencies in their risk management 

activities, particularly with regard to structured credit instruments. The Federal Reserve has long stressed to bankers the importance of proper due diligence and independent analysis in making credit risk assessments. A recent analysis of several global financial institutions by supervisors from the United Kingdom, Germany, France, and the United States—including staff from the 

Federal Reserve—demonstrated that principle in the current environment. Those institutions that had developed robust internal 

processes for assessing risks of complex subprime-related instruments were able to more quickly identify declines in value and the 

heightened risks of these instruments. Accordingly, these institutions were less vulnerable to the underestimates of risk made by 

the credit rating agencies on these instruments, less likely to underestimate the volatility of these instruments, and better able to 

analyze the effects of changing market conditions on their credit 

and liquidity risk profiles. 1

We are reminding institutions that they should conduct independent, thorough, and timely credit risk assessments for all exposures, not just those in the loan book. Their processes for producing 

credit risk assessments should be subject to periodic internal reviews—through financial analysis, benchmarking and other 

means—to ensure that these assessments are objective, accurate 

and timely. Supervisors are also redoubling efforts to ensure that 

institutions do not rely inappropriately on external ratings. We 

continue to emphasize that for any cases in which U.S. banks rely 

on third-party assessments of credit risk, these institutions should 

conduct their own assessments to ensure that they are sound and 

timely and that the level and nature of the due diligence should be 

commensurate to the complexity of the risk. 

In addition, the Federal Reserve and the other members of the 

President’s Working Group on Financial Markets (PWG) have recommended a review of existing regulations and supervisory policies 

that establish minimum external ratings requirements to ensure 

they appropriately take account of the characteristics of securitized 

and other structured finance instruments. The PWG also has endorsed plans by the Basel Committee on Banking Supervision and 

the International Organization of Securities Commissions to reconsider capital requirements for complex structured securities and 

off-balance-sheet instruments that are keyed to ratings provided by 

credit rating agencies. The PWG further has recommended changes 

in the oversight of credit rating agencies and their required disclosures to improve the comparability and reliability of their ratings, 

and expressed support for recent initiatives by the credit rating 

agencies to improve their internal controls and ratings for structured finance instruments. 2

58 

Q.10. HOEPA Rulemaking: During this period of correction in the 

housing market, I believe it is incredibly important that we do not 

overreact and restrict access to credit to individuals who need it 

the most. In December of last year, the Federal Reserve produced 

a proposed rule under its Homeownership Equity Protection Act 

(HOEPA) authority. That rule is currently out for notice and comment. 

Mr. Bernanke, can you comment for the record on some of the 

steps that the Fed took to ensure that an appropriate balance was 

struck between eliminating many of the mortgage market excesses 

that created many of the problems we face today while ensuring 

that borrowers have adequate access to credit? 

A.10. Our goal in proposing new regulations under the authority 

of the Home Ownership and Equity Protection Act (HOEPA) was 

to produce clear and comprehensive rules to protect consumers 

from unfair practices while maintaining the viability of a market 

for responsible mortgage lending. To help us achieve this goal, we 

gathered substantial input from the public, including though five 

public hearings we held on the home mortgage market in 2006 and 

2007. We also focused the proposed protections where the risks are 

greatest by applying stricter regulations to higher-priced mortgage 

loans, which we have defined broadly so as to cover substantially 

all of the subprime market. 

As an example of the Board’s approach, the rules would prohibit 

a lender from engaging in a pattern or practice of making higherpriced loans that the borrower cannot reasonably be expected to 

repay from income or from assets other than the house. The proposal is broadly worded to capture different ways that risk can be 

layered even as the practices that increase risk may change. It 

would not set numerical underwriting requirements, such as a specific ratio of debt to income, but would provide some specific guidance for lenders to follow when assessing a consumer’s repayment 

ability. For instance, creditors who exhibited a pattern or practice 

of not considering consumers’ ability to repay a loan at the fullyindexed rate would be presumed to have violated the rule. 

Another proposed rule would require lenders to verify the income 

or assets they rely on to make credit decisions for higher-priced 

loans. Creditors would be able to rely on standard documents to 

verify income and assets, such as W-2 forms and tax returns. However, to ensure access to credit for consumers, such as the self-employed, who may not easily be able to provide traditional documentation, the rule would allow creditors to rely on any third-party 

documents that provide reasonably reliable evidence of income and 

assets. For example, creditors could rely on a series of check cashing receipts to verify a consumer’s income. 

We believe these proposed rules will help protect mortgage borrowers from unfair and deceptive practices. At the same time, we 

did not want to create rules that were so open-ended or costly to 

administer that responsible lenders would exit the subprime market. So, our proposal is designed to protect consumers without 

shutting off access to responsible credit. 

59 

Q.11. Housing Market: Chairman Bernanke, the current downturn 

in the housing market is not the first that we’ve seen, and is unlikely to be the last. 

What has been the average length of time from peak to trough 

in previous housing market downturns? 

How does the current downturn compare to previous ones? 

A.11. Although there are considerable differences across episodes 

and measures of housing market activity, the trough usually occurs 

between 2 and 3 years after the peak. Thus far, the current downturn in residential investment has lasted eight quarters, similar to 

the average of previous downturns. As measured by single-family 

housing starts, the decline in activity so far in this cycle has been 

greater than average, although not quite as large as the contraction that occurred in the late 1970s and early 1980s. 

Q.12. Home Prices and Inflation: Chairman Bernanke, a commonly 

watched measure of inflation is the core-CPI. Housing constitutes 

almost a third of core-CPI. 

To what extent has the recent decline in housing prices moderated recent increases in the core-CPI? 

What would be the trend in core-CPI if house prices were excluded? 

A.12. The CPI for owner-occupied housing is not directly affected 

by changes in housing prices. The Bureau of Labor Statistics (BLS) 

uses a rental equivalence approach to measure changes in the price 

of housing services from owner-occupied units. This approach defies 

the implicit rent of an owner-occupied unit as the money that 

would be received were it to be rented out (that is, the opportunity 

cost of owning, as opposed to renting, the unit). As a result, the 

BLS uses observations on tenants’ rents (after making adjustments 

for landlord-provided utilities) to construct the CPI for owner-occupied housing. It is reasonable to expect that tenants’ rents should 

be related over time to the affordability of owner-occupied housing, 

which would depend in part on home prices. The BLS does not publish an index for the core CPI excluding owners’ equivalent rent. 

However, one can gain some insight with regard to its limited contribution to core CPI inflation of late from the fact that the CPI 

index for all items less food and energy rose 2.3 percent over the 

12 months ending in February 2008, while the index for owners’ 

equivalent rent of primary residence increased 2.6 percent. 

Q.13. Housing Wealth: Chairman Bernanke, the recent decline in 

home prices in many parts of the country followed several years of 

extraordinary home price appreciation. 

What has been the overall impact of the housing bubble, and its 

burst, on household wealth? Is a family that purchased a home in 

2002 or 2003 still better off? 

Of those families who purchased homes earlier this decade, and 

have seen substantial overall appreciation, how have their spending patterns been affected by the declining market? 

A.13. Nationwide, according to the Office of Federal Housing Enterprise Oversight (OFHEO) purchase-only house price index, 

house prices peaked in mid-2007 and have since fallen about 3 percent; according to the more volatile S&P/Case-Shiller house price 

index, house prices peaked in mid-2006 and have since fallen about 

60 

10 percent. Both indexes show major regional disparities, with 

house prices peaking earlier, and falling more, in California, Nevada, some New England states, and Michigan and Ohio. Indeed, 

according to OFHEO’s measure, home prices in Michigan have fallen, on net, since 2001. In all other states, families that purchased 

their homes in 2003 or earlier continue to have seen a net appreciation in their home’s value. 

According to the Federal Reserve’s flow of funds accounts, housing wealth peaked at $20.3 trillion in 2007:Q3 before falling about 

$170 billion in 2007:Q4. Estimates by academic economists of the 

direct effect of housing wealth on consumption vary widely, from as 

little as 2 cents on the dollar to as high as 7 cents on the dollar. 

These effects tend to be spread out over roughly a 3-year period, 

so that current spending is still being supported to some extent by 

earlier house price gains, and the effects of the current declines 

will only be fully felt over the next couple of years. 

In addition to directly affecting spending by reducing family 

wealth, falling house prices may affect a family’s spending indirectly through credit market channels. Borrowing against home equity is often the lowest-cost form of finance available to a household; falling house prices can decrease the collateral value of a 

home, forcing borrowers to turn to costlier forms of finance, such 

as credit cards. These indirect effects, which are extremely difficult 

to quantify, probably are a factor that has increased the size of 

some of the larger published estimates of the effect of falling house 

prices on consumer spending. 

Q.14. Covered Bonds: Chairman Bernanke, recently FDIC Chairman Bair indicated that covered bonds were a ‘‘front burner issue’’ 

at the FDIC as they continued to look for ways to improve liquidity 

in the mortgage market. I understand that Europe has a mature, 

$2 trillion covered bond market. 

Do you think there could be a benefit to fostering such a market 

in the United States? 

What distinctions do you see between the European market and 

the status of the U.S. market? 

A.14. As long as banks and their counterparties are safe and 

sound, efforts to provide more financing opportunities to banks and 

bank holding companies, particularly under current market conditions, should be taken seriously. Such actions may make it more 

likely that the financial markets will be able to provide the necessary credit to sustain and enhance economic activity. In general, 

the European markets appear to be useful additions to their financial markets, successfully providing liquidity and credit for some 

assets under most market conditions. 

Covered bonds have been available in Europe for many years, 

and such programs differ greatly across countries. Much could be 

learned by studying the merits of each country’s program and applying these lessons to creating a unique program in the United 

States. Creating a covered bond market in the United States, however, may be difficult without Congressional discussion and legislation. Covered bonds raise many issues related to the safety net provided to banks in the United States, including issues related to the 

bank deposit insurance fund. The legal structure provided for covVerDate Nov 24 2008 10:00 Jul 31, 2009 Jkt 048080 PO 00000 Frm 00064 Fmt 6602 Sfmt 6602 S:\DOCS\50369.TXT JASON
61 

ered bonds in European countries resolves many of these issues. 

With regard to creating a covered bond market in the United 

States, all parties should seek to distill the best practices from the 

European markets and work towards the establishment of a robust 

and well-designed covered bond market that includes safeguards to 

ensure that the safety net provided banks would not be measurably 

extended further. 

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