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MONETARY POLICY AND THE 

STATE OF THE ECONOMY 

HEARING 

BEFORE THE

COMMITTEE ON FINANCIAL SERVICES 

U.S. HOUSE OF REPRESENTATIVES 

ONE HUNDRED TWELFTH CONGRESS 

SECOND SESSION 

JULY 18, 2012 

Printed for the use of the Committee on Financial Services 

Serial No. 112–145 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

SPENCER BACHUS, Alabama, Chairman 

JEB HENSARLING, Texas, Vice Chairman 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

STEVAN PEARCE, New Mexico 

BILL POSEY, Florida 

MICHAEL G. FITZPATRICK, Pennsylvania 

LYNN A. WESTMORELAND, Georgia 

BLAINE LUETKEMEYER, Missouri 

BILL HUIZENGA, Michigan 

SEAN P. DUFFY, Wisconsin 

NAN A. S. HAYWORTH, New York 

JAMES B. RENACCI, Ohio 

ROBERT HURT, Virginia 

ROBERT J. DOLD, Illinois 

DAVID SCHWEIKERT, Arizona 

MICHAEL G. GRIMM, New York 

FRANCISCO ‘‘QUICO’’ CANSECO, Texas 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

BARNEY FRANK, Massachusetts, Ranking 

Member 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

JAMES H. CLINGER, Staff Director and Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

July 18, 2012 ..................................................................................................... 1 

Appendix: 

July 18, 2012 ..................................................................................................... 51 

WITNESSES 

WEDNESDAY, JULY 18, 2012 

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

System ................................................................................................................... 7 

APPENDIX 

Prepared statements: 

Paul, Hon. Ron .................................................................................................. 52 

Bernanke, Hon. Ben S. ..................................................................................... 54 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Schweikert, Hon. David: 

U.S. Senate letter regarding PCCRAs ............................................................ 62 

Bernanke, Hon. Ben S.: 

Monetary Policy Report to the Congress, dated July 17, 2012 ..................... 66 

Written responses to questions submitted by Representative Cleaver ........ 126 

Written responses to questions submitted by Representative Hurt ............. 127 

Written responses to questions submitted by Representative McCarthy .... 130 

Written responses to questions submitted by Representative Paul ............. 132 

Written responses to questions submitted by Representative Schweikert .. 134 

(1) 

MONETARY POLICY AND THE 

STATE OF THE ECONOMY 

Wednesday, July 18, 2012 

U.S. HOUSE OF REPRESENTATIVES, 

COMMITTEE ON FINANCIAL SERVICES, 

Washington, D.C. 

The committee met, pursuant to notice, at 10:02 a.m., in room 

2128, Rayburn House Office Building, Hon. Spencer Bachus [chairman of the committee] presiding. 

Members present: Representatives Bachus, Hensarling, Royce, 

Lucas, Paul, Manzullo, Jones, Biggert, Miller of California, Garrett, 

Neugebauer, McHenry, Campbell, Pearce, Posey, Fitzpatrick, Westmoreland, Luetkemeyer, Huizenga, Duffy, Hayworth, Renacci, 

Hurt, Dold, Schweikert, Grimm, Canseco, Fincher; Frank, Waters, 

Maloney, Watt, Sherman, Capuano, Clay, Lynch, Miller of North 

Carolina, Scott, Green, Perlmutter, Donnelly, Carson, Himes, and 

Carney. 

Chairman BACHUS. This hearing will come to order. We meet 

today to receive the semi-annual report to Congress by the Chairman of the Board of Governors of the Federal Reserve System on 

monetary policy and the state of the economy. Pursuant to committee rule 3(f)(2), opening statements are limited to the chair and 

ranking minority member of the full committee, and the chair and 

ranking minority member of the Subcommittee on Domestic Monetary Policy and Technology, for a period of 8 minutes on each side. 

Without objection, all Members’ written statements will be made a 

part of the record. 

I now recognize myself for 5 minutes for the purpose of making 

an opening statement. We are honored to have Federal Reserve 

Chairman Ben Bernanke before us today. Thank you, Chairman 

Bernanke, for appearing before our committee once again, and for 

your dedicated service to the country. 

As we meet this morning, we continue to find our Nation on a 

path that is fiscally and economically unsustainable. And some in 

the Senate, Chairman Bernanke, apparently believe that only you 

can do something about it. Since the economy is bad and unemployment is high, one of those Senators pointedly told you yesterday 

that you have to get to work. That leads to an important question: 

Who is ultimately responsible for the state of our economy? We 

once had a President who had a sign on his desk in the Oval Office 

that said, ‘‘The buck stops here.’’ I will amend that to say the buck 

stops with the President of the United States and with Congress, 

who are the elected leaders of this country. 

2 

The President and Congress are the ones who have created 

America’s spending-driven debt crisis by hitting the gas when what 

was needed was someone stomping on the brakes, and more importantly, the need for reform of our entitlements. Some in the Senate 

may want to duck responsibility, but the truth is the Federal Reserve cannot rescue Americans from the consequences of failed economic and regulatory policies passed by Congress and signed by 

the President. The Chairman of the Fed cannot save the economy 

when those elected leaders decide they are prepared to send our 

country over a fiscal cliff, as one of those elected leaders in the 

Senate declared earlier this week. 

Chairman Bernanke has warned Congress and the Administration time and time again that without action, growing deficits and 

the debt will erode our prosperity and leave the next generation of 

Americans with less opportunity. To avoid this fate, we must start 

taking action now to tame Washington’s appetite for spending, and 

more importantly, as Chairman Bernanke has said, tackle the difficult but necessary long-term restructuring of our entitlements. 

The House, to its credit, has had the courage, in this 

hyperpartisan attack atmosphere, to begin the long-term process; 

the Senate has not. So I would like to take this opportunity to tell 

the Senate that it is time for them to go to work. Our economy is 

hobbled not only by our deficits and debt, but also by the cumulative weight of Washington overregulation. This committee hears 

constantly from private sector witnesses who tell us the regulatory 

burdens being placed on them are, as one small town banker witness said, slowly but surely strangling their ability to do business 

and create jobs. This is not to argue we don’t need regulations. 

Reasonable regulations provide clear rules of the road for businesses and protect consumers. 

Businesses need certainty and to know what to expect. They 

don’t have it under the present regulatory regime. Unfortunately, 

job creators will tell you that reasonable and clear rules aren’t 

what they are getting from Washington right now. Instead, they 

tell us the regulators do not coordinate their actions, and the result 

is businesses are subjected to confusing and often conflicting rules. 

While many in Washington attack Wall Street and big corporations 

when they call for more regulation, the reality is the burden of 

Federal red tape falls disproportionately on small businesses and 

the small community-based financial institutions that lend to them. 

As the Small Business Administration reports, it costs small 

businesses 36 percent more per employee to comply with Federal 

rules than large companies. This has driven a consolidation which 

is evident in our financial services industry. And because small 

businesses are the engine of job growth in our economy, we can 

hardly blame the Fed when policies passed by this Congress and 

signed by the President result in regulatory overkill that makes it 

harder for small businesses to thrive and hire. 

Instead of more regulations, Congress and the President need to 

do more to eliminate the government roadblocks that stand in the 

way of small business success and job creation. The President recently said that entrepreneurs and small businesses aren’t successful on their own; they can succeed only with the help of the government. That is akin to saying that Apple Computer is a success beVerDate Nov 24 2008 18:12 Mar 21, 2013 Jkt 076116 PO 00000 Frm 00006 Fmt 6633 Sfmt 6633 K:\DOCS\76116.TXT TERRI
3 

cause of the person who built Steve Jobs’s garage. Small businesses 

succeed in this country in spite of the government, not because of 

it. 

Chairman Bernanke, I know all of us look forward to your testimony and the discussion that we will have today. Again, I thank 

you for being here, and I yield to the ranking member. 

Mr. FRANK. I appreciate that. I am always struck by the ability 

of my Republican colleagues to engage in a kind of duality of the 

mind with regard to Federal spending. I listened to the chairman 

talk about the need to rein in spending, and note that we are going 

to be given a bill today to vote on that will increase military spending beyond what the President has asked for. 

There is this curious notion that somehow military spending is 

very different from all other government spending. People who tell 

us how government spending never creates a job become the most 

militant Keynesians when it comes to military spending, even 

though a very large percentage of it is spent overseas. We will be 

asked today to continue a subsidy to NATO so that the wealthy nations of western Europe can continue to spend very little on their 

military, so that they in turn can have lower retirement ages than 

we have here in America, and we will then be telling Americans 

that we have to cut back on their Social Security and their Medicare. 

Note when my Republican friends say ‘‘entitlement,’’ they mean 

Social Security and Medicare. And I am proud of those. While we 

can make them more efficient, I am not prepared to maintain more 

and more military spending at their expense. 

Next, I want to comment on what Chairman Bernanke has told 

us. And I want to begin by noting that when people look for bipartisanship, it is striking the degree of partisan criticism I have 

heard from Republicans of Chairman Bernanke, who is singlehandedly the most bipartisan institution in Washington. He was 

appointed 3 times to important economic positions by George Bush: 

first, to the Federal Reserve Board of Governors in 2002; second, 

to be Chairman of the Council of Economic Advisers in 2005; and 

third, to be Chairman of the Federal Reserve. 

It does appear that when Mr. Bush had an important economic 

appointment to make, he said, get me the usual suspect, which was 

Chairman Bernanke. And I think that is very important, because 

he is genuinely bipartisan, and therefore, I look at his analysis of 

the economy. And it has very little do with the very partisan caricature we hear. 

I read the economic report, the Monetary Policy Report; there is 

a basic statement that our economy has been recovering from the 

terrible crisis brought about by the complete absence of regulation 

and consequent, unchecked irresponsibility by some financial institutions, obviously not all, and we are told that it is slowed down 

by a number of factors. The most important, according to the way 

it is presented here, is what is going on in Europe. Nothing that 

we have done is responsible. In fact, the Federal Reserve has tried 

to be helpful in alleviating the situation in Europe, drawing again 

partisan criticism from the Republicans for their cooperation with 

the ECB to ease that situation to our benefit. We are told that 

there is a problem because there is uncertainty about the tax and 

4 

spending policies. But those are wholly bipartisan. By the way, I 

voted against the bill that included the sequester. I think we can 

substantially cut military spending, but sequestering is a stupid 

way to do it. 

A better way to do it would be to tell western Europe they are 

on their own, to stop figuring that we have to win a thermonuclear 

war with a now nonexistent Soviet Union. But the fact is that the 

uncertainty that Chairman Bernanke talks about, our bipartisan 

Republican and Democratic-appointed top economic official, is an 

uncertainty that is bipartisan and has nothing to do with regulation. And I listen to this complaint about regulatory uncertainty. 

Apparently, maybe there is a part of the Monetary Policy Report 

I haven’t read. I don’t see a word in here that says that financial 

reform or other forms of regulation are part of the problem. It does 

talk about some other things that are part of the problem, for example, the cutback in hiring and construction by State and local 

governments. And that is a direct preference of the Republicans. 

We began in 2009, when we had a President and a Democratic 

Congress, to provide funding so State and local governments could 

continue to be economically active in the face of the crisis that had 

hit them. We were told by our Republican colleagues that was government spending; it didn’t create jobs. Apparently, you couldn’t 

shoot anybody with it. And if you can’t shoot anybody with something, or if you can’t send it to an overseas base, it has no job creation impact, so they only do it for the military. But in fact, if State 

and local governments had not been forced to cut back, unemployment would now be below 8 percent, even if they had been able to 

hold even. 

We have lost about 15 percent of the jobs created in the private 

sector by cutbacks in the public sector. So again, as I read this, 

there are discussions of what is causing a recovery slower than we 

want it to be. None of them have to do with what my Republican 

colleagues have said. And again, this comes from Chairman 

Bernanke, who was, as I said, was appointed 3 times to important 

economic positions by George Bush, a man with whom I sometimes 

disagree, but whose integrity and intellectual honesty ought to be 

unquestioned. Unfortunately, in this hyperpartisan atmosphere, to 

quote the chairman, it sometimes isn’t. 

Chairman BACHUS. I thank the ranking member. Before recognizing Dr. Paul for his statement, I want to note that this may be 

his last committee meeting with the Chairman of the Federal Reserve. Throughout his time in office, Dr. Paul has been a consistent 

and strong advocate for sound monetary policy. And his leadership 

on the committee, especially during these hearings when we have 

had the Federal Reserve Chairman up here before us, have certainly made the hearings more interesting and provided several 

memorable YouTube moments. 

Mr. FRANK. Mr. Chairman, could I ask unanimous consent just 

to say that having served for a long time with Ron Paul, with 

whom I agree on on a number of issues, I am very pleased that I 

was able to serve one term with him as the chairman, because 

there were times during our joint service when despite his seniority, I thought he would never get to it. So I am glad that he finally 

achieved that chairmanship that he should have had long ago. 

5 

Chairman BACHUS. Thank you. And let me note that my statement didn’t talk about Democrats and Republicans. 

Mr. FRANK. Mr. Chairman, if we are going to debate it, I know 

you talked about the Administration and Obama, and I think most 

people know what party he is in. 

Chairman BACHUS. All right. Thank you. For the record, we do 

know that. Thank you. Dr. Paul for 3 minutes. 

Dr. PAUL. Thank you, Chairman Bachus. And welcome, Chairman Bernanke. I appreciate your comments, Chairman Bernanke 

and Ranking Member Frank. I am delighted to be here today, but 

I just want to refresh a few people’s memories. I was first elected 

to Congress in 1976 in April in a special election. And the biggest 

bill on the docket at that time was the revamping of the IMF. 

There was a major crisis going on from the breakdown of the 

Bretton Woods agreement, and they had to rewrite the laws. They 

wanted to conform the laws with what they had been doing for 5 

years. And that was a major piece of legislation. But it was only 

a consequence of what was predicted in 1945, because when 1945 

established that Bretton Woods, it was predicted by the free market economists that it wouldn’t work, that it would fail. 

This whole idea that they could regulate exchange rates and deal 

with the balance of payments totally failed. And so, they had to 

come up with something new. And 1971–1976 is that transition period. Those same economists at that time said this was an unworkable system, too, and it would lead to a major crisis of too much 

debt, too much malinvestment. It would be worldwide. It would be 

worse than anything because it would be based on the fiat dollar 

globally, and many of the problems we have domestically would be 

worldwide. 

That certainly has been confirmed with the crisis that we are in, 

and it has not been resolved yet. We are still floundering around, 

and we still have a long way to go. 

I have, over the years, obviously been critical of what goes on in 

monetary policy, but it hasn’t been so much of the Chairman of the 

Federal Reserve, whether it was Paul Volcker or Alan Greenspan 

or the current Chairman; it has always been the system. I think 

they have a job that they can’t do because it is an unmanageable 

job. And it is a fallacy, it is a flawed system, and therefore we 

shouldn’t expect good results. 

And generally, we are not getting results. Policies never change. 

We say the same thing. No matter what the crisis is, we still do 

more of the same. If spending and debt was the problem, spending 

more and in greater debt and have the Fed just buy more debt 

doesn’t seem to help at all. And here we are doing the same thing. 

We don’t talk about the work ethic and true productions and true 

savings and why this excessive debt is so bad for us. We talk about 

solving a worldwide problem of insolvency of nations, including our 

own, by just printing money, and creating credit. 

The Fed, in the last 4 years, tripled the monetary base, and it 

has $1 trillion more money sitting there, and the banks are sitting 

with trillions of dollars. Just the creation of money doesn’t restore 

the confidence that is necessary. And until we get to the bottom of 

this and restore the confidence, I don’t think we are going to see 

economic growth. This whole idea that you have the job of manVerDate Nov 24 2008 18:12 Mar 21, 2013 Jkt 076116 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 K:\DOCS\76116.TXT TERRI
6 

aging money, and we can’t even define the dollar—nobody has a 

definition of the dollar; it is an impossible task. 

So I have hoped in the past to try to contribute to the discussion 

on monetary policy and the business cycle and why it benefits the 

rich over the poor, and so far, my views have not prevailed. But 

I have appreciated the opportunity, and I appreciate this opportunity to have served on the Financial Services Committee. 

Chairman BACHUS. Thank you. Thank you, Dr. Paul. The gentleman from Missouri, Mr. Clay, is recognized for 3 minutes. 

Mr. CLAY. Thank you, Mr. Chairman. And let me thank Chairman Bernanke for appearing at today’s hearing. Let me also publicly thank our subcommittee chairman, Dr. Paul, for his honorable 

service in Congress and to his country. As you know, the Humphrey-Hawkins Act charges the Federal Reserve with a dual mandate: to maintain stable prices, which I understand we have positive news about; and full employment, which is what I would like 

to talk about today. Full employment means everyone. Currently, 

the national average unemployment rate is 8.2 percent. 

Chairman Bernanke, this has decreased compared with when 

you were here a year ago, when it was 9.1 percent. Unfortunately, 

the unemployment rate for African Americans is much higher. For 

African-American males, it is a too-high 14.2 percent. 12.7 million 

people in the United States want to work, but cannot find a job. 

That is down from last year’s 14 million. But too many of those 

12.7 million are African Americans. Nonfarm payroll employment 

is continuing to rise by 80,000, but too few of those who are getting 

jobs are African Americans. Average hourly earnings for all private 

nonfarm employees rose to $23.50 over the past 12 months, but not 

for enough African Americans. 

Consumer food prices have risen slightly, but consumer price inflation has decreased overall, and energy prices have decreased too. 

But if you are out of work, you cannot pay your electric bill even 

if it is slightly lower than it was last year. The disparity in the unemployment between the national average and African Americans 

is unacceptable, and we have to do more to solve it. Mr. Chairman, 

it is important to put everyone back to work in this country. But 

as we look at policies and strategies that will continue the improvement in job numbers, be aware that we as a Nation are only as 

strong as the weakest link. 

So let’s make sure we don’t leave behind a large and important 

part of our communities. And I look forward to your statement and 

continuing this important and ongoing discussion. Mr. Chairman, 

I yield back. 

Chairman BACHUS. Thank you, Mr. Clay. Before I recognize 

Chairman Bernanke, let me say that because the Financial Stability Oversight Council on which the Chairman serves is meeting 

today at 1 p.m., the Chair will excuse Chairman Bernanke at 

12:45, so that he can fulfill his important obligation with that 

Council. The Chair also announces that in order to accommodate 

questioning of Chairman Bernanke by as many Members as possible, we will strictly enforce the 5-minute rule. 

Members who wait until the final seconds of their 5 minutes to 

begin asking their questions to the Chairman should be advised 

that they will be asked to suspend when the red light comes on so 

7 

that we can allow all Members to be recognized. I have often said 

that our freshman class and sophomore class are some of our more 

capable Members, and I want them to have an opportunity to ask 

questions. 

Chairman Bernanke, your written statement will be made a part 

of the record, and you are now recognized for a summary of your 

testimony. 

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

SYSTEM 

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

Frank, and members of the committee. I am pleased to present the 

Federal Reserve’s semi-annual Monetary Policy report to the Congress. Let me begin with a discussion of current economic conditions and the outlook, and then I will talk a bit about monetary 

policy. The U.S. economy has continued to recover, but economic 

activity appears to have decelerated somewhat during the first half 

of the year. After rising at an annual rate of 2.5 percent in the second half of 2011, real GDP increased at a 2 percent pace in the 

first quarter of this year, and available indicators point to a still 

smaller gain in the second quarter. Conditions in the labor market 

improved during the latter part of 2011 and early this year, with 

the unemployment rate falling about a percentage point over that 

period. However, after running at nearly 200,000 per month during 

the fourth and first quarters, the average increase in payroll employment shrank to 75,000 per month during the second quarter. 

Issues related to seasonal adjustment and the unusually warm 

weather this past winter can account for a part, but only a part, 

of this loss of momentum in job creation. At the same time, the jobless rate has recently leveled out at just over 8 percent. Household 

spending has continued to advance, but recent data indicate a 

somewhat slower rate of growth in the second quarter. Although 

declines in energy prices are now providing support to consumers’ 

purchasing power, households remain concerned about their employment and income prospects and their overall level of confidence 

remains relatively low. One area where we see modest signs of improvement is housing. In part, because of historically low mortgage 

rates, both new and existing home sales have been gradually 

trending upward since last summer, and some measures of house 

prices have turned up in recent months as well. 

Construction has increased, especially in the multi-family sector. 

Still, a number of factors continue to impede progress in the housing market. On the demand side, many would-be buyers are deterred by worries about their own finances or about the economy 

more generally. Other prospective home buyers cannot obtain mortgages due to tight lending standards, impaired creditworthiness, or 

because their current mortgages are underwater, that is, they owe 

more than their homes are worth. 

On the supply side, the large number of vacant homes, boosted 

by the ongoing inflow of foreclosed properties, continues to divert 

demand from new construction. After posting strong gains over the 

second half of 2011 and into the first quarter of 2012, manufacturing production has slowed in recent months. Similarly, the rise 

8 

in real business spending on equipment and software appears to 

have decelerated from the double digit pace seen over the second 

half of 2011 to a more moderate rate of growth over the first part 

of this year. Forward-looking indicators of investment demand, 

such as surveys of business conditions and capital spending plans, 

suggest further weakness ahead. 

In part, slowing growth in production and capital investment appears to reflect economic stresses in Europe, which together with 

some cooling in the economies of other trading partners, is restraining the demand for U.S. exports. At the time of the June 

meeting of the Federal Open Market Committee, or FOMC, my colleagues and I projected that under the assumptions of appropriate 

monetary policy, economic growth will likely continue at a moderate pace over coming quarters and then pick up very gradually. 

Specifically, our projections for growth in real GDP prepared for 

the meeting had a central tendency of 1.9 to 2.4 percent for this 

year, and 2.2 to 2.8 percent for 2013. These forecasts are lower 

than those we made in January, reflecting the generally disappointing tone of the recent incoming data. In addition, financial 

strains associated with the crisis in Europe have increased since 

earlier this year, which, as I already noted, are weighing on both 

global and domestic economic activity. 

The recovery in the United States continues to be held back by 

a number of other headwinds, including still tight borrowing conditions for some businesses and households and, as I will discuss in 

more detail shortly, the restraining effects of fiscal policy and fiscal 

uncertainty. Moreover, although the housing market has shown improvement, the contribution of this sector to the recovery is less 

than has been typical of previous recoveries. These headwinds 

should fade over time, allowing the economy to grow somewhat 

more rapidly and the unemployment rate to decline toward a more 

normal level. 

However, given that growth is projected to be not much above 

the rate needed to absorb new entrants to the labor force, the reduction in the unemployment rate seems likely to be frustratingly 

slow. Indeed, the central tendency of participants’ forecasts now 

has the unemployment rate at 7 percent or higher at the end of 

2014. The committee made comparatively small changes in June to 

its projections for inflation. Over the first 3 months of 2012, the 

price index for personal consumption expenditures rose about 3.5 

percent at an annual rate, boosted by a large increase in retail energy prices that, in turn, reflected the higher costs of crude oil. 

However, the sharp drop in crude oil prices in the past few months 

has brought inflation down. 

In all, the PCE price index rose at an annual rate of 1.5 percent 

over the first 5 months of this year, compared with a 2.5 percent 

rise over 2011 as a whole. The central tendency of the Committee’s 

projections is that inflation will be 1.2 to 1.7 percent this year, and 

at or below the 2 percent level that the Committee judges to be 

consistent with its statutory mandate in 2013 and 2014. Participants at the June FOMC meeting indicated that they see a higher 

degree of uncertainty about their forecasts than normal, and that 

the risks to economic growth have increased. I would like to highlight two main sources of risk. The first is the euro-area fiscal and 

9 

banking crisis, and the second is the U.S. fiscal situation. Earlier 

this year, financial strains in the euro-area moderated in response 

to a number of constructive steps by the European authorities, including the provision of 3-year bank financing by the European 

Central Bank. However, tensions in euro-area financial markets intensified again more recently, reflecting political uncertainties in 

Greece, and news of losses at Spanish banks, which in turn raised 

questions about Spain’s fiscal position and the resilience of the 

euro-area banking system more broadly. Euro-area authorities 

have responded by announcing a number of measures, including 

funding for the recapitalization of Spain’s troubled banks, greater 

flexibility in the use of the European financial backstops, and 

movement toward unified supervision of euro-area banks. Even 

with these announcements, however, Europe’s financial markets 

and economy remain under significant stress, with spillover effects 

on financial and economic conditions in the rest of the world, including the United States. 

Moreover, the possibility that the situation in Europe will worsen 

further remains a significant risk to the outlook. The Federal Reserve remains in close communication with our European counterparts. Although the politics are complex, we believe that the European authorities have both strong incentives and sufficient resources to resolve the crisis. At the same time, we have been focusing on improving the resilience of our financial system to severe 

shocks, including those that might emanate from Europe. The capital and liquidity positions of U.S. banking institutions have improved substantially in recent years, and we have been working 

with U.S. financial firms to ensure that they are taking steps to 

manage the risks associated with their exposures to Europe. 

That said, European developments that resulted in a significant 

disruption in global financial markets would inevitably pose significant challenges for our financial system and for our economy. The 

second important risk to our recovery, as I mentioned, is the domestic fiscal situation. As is well known, U.S. fiscal policies are on 

an unsustainable path, and the development of a credible mediumterm plan for controlling deficits should be a high priority. 

At the same time, fiscal decisions should take into account the 

fragility of the recovery. That recovery could be endangered by the 

confluence of tax increases and spending reductions that will take 

effect early next year if no legislative action is taken. The CBO has 

estimated that if the full range of tax increases and spending cuts 

were allowed to take effect, a scenario widely referred to as the 

‘‘fiscal cliff,’’ a shallow recession, would occur early next year, and 

about 11⁄4 million fewer jobs would be created in 2013. These estimates do not incorporate the additional negative effects likely to result from public uncertainty about how these matters will be resolved. 

As you recall, market volatility spiked and confidence fell last 

summer in part as a result of the protracted debate about the necessary increase in the debt ceiling. Similar effects could ensue as 

the debt ceiling and other difficult fiscal issues come into clearer 

view toward the end of the year. The most effective way that Congress could help to support the economy right now would be to 

work to address the Nation’s fiscal challenges in a way that takes 

10 

into account both the need for long-run sustainability and the fragility of the recovery. Doing so earlier rather than later would help 

reduce uncertainty and boost household and business confidence. 

Finally, on monetary policy, in view of the weaker economic outlook, subdued projected path for inflation, and the significant 

downside risk to economic growth, the FOMC decided to ease monetary policy at its June meeting by continuing its Maturity Extension Program, or MEP, through the end of this year. The MEP 

combines sales of short-term Treasury securities with an equivalent amount of purchases of longer-term Treasury securities. As a 

result, it decreases the supply of longer-term Treasury securities 

available to the public, putting upward pressure on the prices of 

those securities and downward pressure on their yields, without affecting the overall size of the Federal Reserve’s balance sheet. By 

removing additional longer-term Treasury securities from the market, the Fed’s asset purchases also induced private investors to acquire other longer-term assets such as corporate bonds and mortgage-backed securities, helping to raise their prices and lower their 

yields, and thereby making broader financial conditions more accommodative. 

Economic growth is also being supported by the exceptionally low 

level of the target range for the Federal funds rate from zero to 

one-fourth percent and the economy’s forward guidance regarding 

the anticipated path of the funds rate. 

As I reported in my February testimony, the FOMC extended its 

forward guidance in January, noting that it expects that economic 

conditions, including low rates of resource utilization and a subdued outlook for inflation over the medium run, are likely to warrant exceptionally low levels for the Federal funds rate at least 

through late 2014. The Committee has maintained this conditional 

forward guidance at its subsequent meetings. Reflecting its concerns about the slow pace of progress in reducing unemployment 

and the downside risk to the economic outlook, the Committee 

made clear at its June meeting that it is prepared to take further 

action, as appropriate, to promote a stronger economic recovery and 

sustained improvement in labor market conditions in a context of 

price stability. Thank you, Mr. Chairman. I would be happy to answer your questions. 

[The prepared statement of Chairman Bernanke can be found on 

page 54 of the appendix.] 

Chairman BACHUS. Thank you, Chairman Bernanke. Next week, 

the House will be voting on Dr. Paul’s bill to audit the Federal Reserve. Would you please give us your views on the legislation? 

Mr. BERNANKE. Yes. Thank you. I absolutely agree with Dr. Paul 

that the Federal Reserve needs to be transparent and it needs to 

be accountable. I would argue that at this point, we are quite 

transparent and accountable. On monetary policy, besides our 

statement, besides our testimonies, we issue minutes after 3 weeks, 

we have quarterly projections, I give a press conference 4 times a 

year. There is quite a bit of information provided to help Congress 

evaluate monetary policy, as well as the public. Also, very importantly, the Federal Reserve’s balance sheet, its finances, and its operations are thoroughly vetted. We produce an annual financial 

statement which is audited by an independent external accounting 

11 

firm. We provide quarterly updates and a weekly balance sheet. We 

have an independent Inspector General (IG.) 

We have additional scrutiny imposed by the Dodd-Frank Act. 

And very importantly, and this is, I think, the crux of the matter, 

the U.S. Government Accountability Office, the GAO, has extensive 

authority, broad authority to audit essentially all aspects of the 

Federal Reserve. And the Federal Reserve accepts that, and is cooperative with the GAO’s efforts. 

There is, however, one important exception to what the GAO is 

allowed to audit under current law, and that specifically is monetary policy deliberations and decisions. So what the audit of the 

Fed bill would do would be to eliminate the exemption for monetary policy deliberations and decisions from the GAO audit. So in 

effect, what it would do is allow Congress, for example, to ask the 

GAO to audit a decision taken by the Fed about interest rates. 

That is very concerning because there is a lot of evidence that 

an independent central bank that makes decisions based strictly on 

economic considerations, and not based on political pressure, will 

deliver lower inflation and better economic results in the longer 

term. 

So, again, I want to agree with the basic premise that the Federal Reserve should be thoroughly transparent, and thoroughly accountable. I will work with everyone here to make sure that is the 

case. But I do feel it is a mistake to eliminate the exemption for 

monetary policy and deliberations, which would effectively, at least 

to some extent, create a political influence or political dampening 

effect on the Federal Reserve’s policy decisions. Thank you, Mr. 

Chairman. 

Chairman BACHUS. Thank you. I will note that bill did not come 

before the Financial Services Committee, which surprised me. 

Throughout your tenure as Chairman, you have warned this committee and others about the dangers of the U.S. fiscal position, the 

annual deficit, and the growing national debt. And now, we are facing what you call correctly a fiscal cliff next January. 

I mentioned in my opening statement the need for long-term restructuring of our entitlements. And as the ranking member said, 

I was talking about Medicaid, Medicare, and to a lesser extent, Social Security. Would you tell us why you are concerned about the 

fiscal cliff, what will happen to the economy if we don’t do anything 

to address it, and what long-term strategies Congress should be 

thinking about as we address these issues? 

Mr. BERNANKE. Certainly. Thank you. First, I think there is very 

little disagreement that the U.S. fiscal situation is not sustainable. 

Under current law, deficits will continue to grow, interest will continue to accumulate, and ultimately we will simply not be able to 

pay our bills. So it is very important over the long term to make 

decisions collectively about tax and spending policies that will 

bring our fiscal situation into a more sustainable configuration. 

Now that, I should add, is very much a long-run proposition. 

Many of the issues that affect our long-term fiscal sustainability 

are decades rather than months or quarters in the future. And 

therefore, I think—I would just suggest, if I might, that in looking 

at these issues, we might want to go beyond the 10-year window 

12 

which is usually the basis for fiscal decisions, and at least consider 

implications of actions for even longer horizons. 

So it is very important for fiscal stability, for financial stability, 

for Congress to provide a credible plan for stabilizing our long-term 

fiscal situation as soon as possible. That is a long run proposition, 

however. And the way the current law is set up, we are going to 

have a very, very sharp contraction in the fiscal situation, increased taxes, and cuts in spending, that are very dramatic and 

that occur almost simultaneously on January 1, 2013. 

As I discussed in my remarks, and as the CBO has documented 

in some detail, if that all happens, it will, no doubt, do serious 

damage to the recovery, and probably will cost a significant number of jobs. It is not essential to do it that way. I think the best 

way to address this is to attack the long-run fiscal sustainability 

issue seriously and credibly, but to do it in a more gradual way 

that doesn’t have such negative effects on the recovery. And I think 

both of those goals can be met simultaneously, recognizing that it 

is not politically easy. But I believe that is the correct broad approach for addressing our fiscal situation. 

Chairman BACHUS. Thank you. The ranking member is recognized for 5 minutes for questioning. 

Mr. FRANK. Mr. Chairman, you say on page 6 that we should address the fiscal challenges in a way that takes into account both 

the need for long-range sustainability and the fragility of the recovery. There are some in the Congress who have been arguing that 

it is very important in the appropriations we are now voting on for 

the fiscal year that begins in a couple of months that we substantially reduce what we are committed to spend. Is that what you are 

warning us against when you talk about the fragility of the recovery? Is it the timing issue, that we should not be trying to do this 

in the immediate next fiscal year, but put into place a longer-term 

situation? 

Mr. BERNANKE. I am talking about the collective impact of the 

tax increases and the spending cuts, which together come something close to 5 percent of GDP, which would, if it all hit at the 

same time, be very negative for growth. It is important to combine 

a more gradual approach with, of course, a longer-term plan to address sustainability. 

Mr. FRANK. Let me ask you, you have been doing a great deal 

with your colleagues to try to provide an impetus to economic 

growth, at least an offset to the headwinds I think would be the 

way to put it. A number of people from the beginning of your efforts to do this, quantitative easing and the twist and all the other 

ways that you have been trying to make more money available, 

have warned that you were risking inflation, and some have said 

that this might worsen our fiscal condition because you might be 

losing money. You are aware of the criticisms. This many, I don’t 

know, a couple of years into this, what is the record? Were you 

wrong? 

Mr. BERNANKE. No, we are not wrong. I have a collection of opeds and editorials from 2008 and 2009 about immediate hyperinflation which is right around the corner, collapse of the dollar, 

those sorts of things. None of that has happened. None of that is 

13 

going to happen. The Federal Reserve is responsibly using monetary policy to try to support the recovery. 

We are very cognizant of our responsibility for price stability, 

and we have the tools to withdraw the policy stimulus at the appropriate time. But markets, for example as reflected in interest 

rates and inflation-adjusted Treasury securities, suggest that markets are quite confident that inflation will remain low. 

Mr. FRANK. Thank you, Mr. Chairman. I will share with you an 

insight that I am sure you have already figured out for yourself. 

But being able to say, ‘‘I told you so’’ is one of the few pleasures 

that improves with age. And you are certainly entitled to do that 

with the people who were crying wolf. Part of the problem though, 

was it was ideologically motivated, some of this criticism. That is 

there are people, and we have legislation that has been introduced, 

they are holding it off until after the election because they don’t 

want to, I think, be seen supporting it too popularly, but people 

will advance it if they can, which would cut in half your dual mandate. 

You are mandated by the law under which you appear today to 

be equally concerned about price stability and employment. And 

there are some who argue that is inconsistent, and that you have, 

in fact, been distracted from your focus on price stability by this 

equal mandate on employment. 

I believe, by the way, that is part of what people are trying to 

get at with the audit. Because as you say, we have put into the law 

already auditing of all your financial transactions, any activity you 

have with a private company will sometimes be public. I believe 

this is part of an effort to undermine the dual mandate indirectly. 

They will try do it directly if they can later. Have you found any 

inconsistency between the two parts of the mandate? Has the concern for employment, which I admire you for showing, interfered 

with your ability to bring about price stability? 

Mr. BERNANKE. As you noted, inflation is low. It is in fact a little 

bit below our 2 percent target, so there has not been an evident inconsistency. And I think the dual mandate has served us well, and 

we do have the ability to address both sides. That being said, we 

will do of course whatever Congress tells us to do. 

Mr. FRANK. But have you found any inconsistency in meeting 

both aspects of the dual mandate? 

Mr. BERNANKE. Generally speaking, no. In particular, low inflation does contribute to healthy employment in the longer term. So, 

they are complementary in that respect. 

Mr. FRANK. And your efforts to help the economy overcome the 

headwinds have not led to any inflation? 

Mr. BERNANKE. No. 

Mr. FRANK. Another argument we have seen is that it is regulation that is slowing things down. You talked about the headwinds. 

I notice you did not mention the committee meeting you are about 

to go to as one of those headwinds. Having talked to us about the 

headwinds, in your judgment the financial reform legislation that 

we passed, is that one of the headwinds? 

Mr. BERNANKE. I wouldn’t want to rule out regulatory and tax 

factors as part of the uncertainty. There are a lot of uncertainties 

in the economy. 

14 

Mr. FRANK. I don’t mean in theory; I mean the one that we have 

adopted. 

Mr. BERNANKE. It is possible that some of these regulations have 

some impact on the cost of credit, but there has been a lot of analysis that suggests that the benefits in terms of reducing the risk 

of a financial crisis are extremely large, and that whatever costs 

are involved are worthwhile. 

Mr. FRANK. I thank you. I hope, with that analysis from our bipartisan appointee here, that some of my colleagues who preach 

the virtues of benefit cost analysis will not ignore its benefits as 

you have just mentioned them. Thank you, Mr. Chairman. 

Chairman BACHUS. Thank you. Dr. Paul for 5 minutes. 

Dr. PAUL. Thank you, Mr. Chairman. I had a question prepared, 

but I think I better follow up on the question you asked Chairman 

Bernanke dealing with the audit of the Fed. Because when the Fed 

talks about independence, what they are really talking about is secrecy, not transparency. And it is the secrecy that I don’t like and 

that we have a right to know about. 

What the GAO cannot audit, and I believe it would be the position of the Chairman, is it cannot audit monetary policy. And you 

expressed yourself on monetary policy. It would not be able to look 

at agreements and operations with foreign central banks and governments and other banks, or transactions made under the direction of the FOMC, discussions or communications between the 

Board and the Federal Reserve system related to all those items. 

It is really not an audit without this. It is still secrecy. And why 

this is important is because of what happened 4 years ago. It is estimated that the amount of money that went in and out of the Fed 

for the bailout overseas was $15 trillion. How did we ever get into 

this situation where Congress has nothing to say about trillions 

and trillions of dollars bailing out certain banks and governments 

through these currency swaps? 

And the Chairman has publicly announced that he is available, 

there is a crisis going on in Europe, part of this dollar crisis going 

on that has been building. It is unique to the history of the world 

of monetary policy. And we stand ready. Who stands ready? The 

American taxpayer, because we are just going to print up the 

money. As long as they take our dollars, we will print the money 

and we will bail them all out and we are going to destroy the middle class. The middle class is shrinking. The banks get richer, and 

the middle shrinks, they lose their houses, they lose their mortgages. 

The system is biased against the middle class and the poor. So 

I would say that if we protect this amount of secrecy, it is not good 

policy and it is not good economics at all, and it is very unfair. But 

my question is, Mr. Chairman, whose responsibility is it under the 

Constitution to manage monetary policy? Which branch of government has the absolute authority to manage monetary policy? 

Mr. BERNANKE. The Congress has the authority, and it has delegated it to the Federal Reserve. That is a policy decision that you 

have made. 

Dr. PAUL. Yes, but they can’t transfer authority. You can’t amend 

the Constitution by just saying we are going to create some secret 

group of individuals and banks. That is amending the Constitution. 

15 

You can’t do that, and all of a sudden allow this to exist in secrecy. 

Whose responsibility is it for oversight? Which branch of government has the right of oversight? 

Mr. BERNANKE. Congress has the right of oversight. And we certainly fully accept that, and we fully accept the need for transparency and accountability. But it is a well-established fact that an 

independent central bank will provide better outcomes. There is no 

constitutional reason why Congress couldn’t take over monetary 

policy. If you want to do that, I guess that is your right to do it. 

But I am advising you that it wouldn’t be very good from an economic policy point of view. 

Dr. PAUL. Yes, but if it is allowed to be done in secret, this is 

the reason why I want to work within the system. What I want to 

say is Congress ought to get a backbone. They ought to say we deserve to know, we have a right to know, we have an obligation to 

know because we have an obligation to defend our currency. It is 

the destruction of the currency that destroys the middle class. 

There is a principle in free market banking that says if you destroy 

the value of currency through inflation, you transfer the wealth 

from the middle class and it gravitates to the very wealthy. The 

bankers, the government, the politicians, they all love this. It is a 

fact that the Federal Reserve is the facilitator. You couldn’t have 

big government—if everybody loves big government, loves the Fed, 

because they can finance the wars and all the welfare you want. 

But it doesn’t work, and it eventually ends up in a crisis. It is a 

solvency crisis, and it can’t be solved by printing a whole lot of 

money. 

So I think the very first step is transparency, and for us to know. 

We have a right to know. And you may be correct in your assumption, at least I am sure you believe this, but maybe I should be 

talking to the Congress that we should stand up and say, yes, we 

demand to know. Trillions and trillions of dollars being printed out 

of thin air, and bailing out their friends. They stand ready to do 

it. The crisis is just, as far as I am concerned, my opinion is it is 

in the early stages. It is far from over. We are in deep doldrums, 

and we never change policy. We never challenge anything. We just 

keep doing the same thing. 

Congress keeps spending the money. Welfare expands exponentially. Wars never end. And deficits don’t matter. And when it 

comes to cutting spending, Republicans and Democrats get together 

and say, oh, no, we can’t really cut. And if we do cut, we just cut 

proposed increases. 

Mr. FRANK. Mr. Chairman, regular order. Regular order, Mr. 

Chairman. 

Dr. PAUL. And you stand there and facilitate it all. 

Chairman BACHUS. Thank you, Dr. Paul. Congressman Clay for 

5 minutes. 

Mr. FRANK. Can we get the answer in writing to that question, 

Mr. Chairman? 

Mr. BERNANKE. May I just comment, Congressman Paul, your objections are to the structure of the system, as you mentioned. But 

all of the actions we took during the crisis, the swaps, all of those 

things are fully disclosed. It is not a question of information. It is 

a question of whether or not you want to give the Fed those powVerDate Nov 24 2008 18:12 Mar 21, 2013 Jkt 076116 PO 00000 Frm 00019 Fmt 6633 Sfmt 6633 K:\DOCS\76116.TXT TERRI
16 

ers. If you don’t want to, of course, Congress has the right to take 

them back. 

Mr. CLAY. Thank you. 

Mr. FRANK. Will the gentleman yield me 10 seconds? 

Mr. CLAY. I yield to the ranking member. 

Mr. FRANK. Just to mention that, in fact, in the financial reform 

bill, I think unanimously, while there were some differences, we repealed Section 13(3) of the Federal Reserve Act, which was the single biggest grant of power to the Federal Reserve to lend any 

money it wanted if it thought there was a chance to do it. It was 

the AIG loan. So in fact, this Congress, in 2010, made a substantial 

reduction in the Federal Reserve’s authority. 

Mr. CLAY. Chairman Bernanke, the national unemployment rate 

is 8.2 percent, lower than it was a year ago. And as I said, it is 

important to put all Americans back to work. But I am troubled by 

the large disparity between the unemployment rate in the country 

at large and that of African Americans, which is at 8.2 percent 

versus 14.2 percent. I think that is a national crisis. Mr. Chairman, 

to what do you believe this large difference can be attributed? 

Mr. BERNANKE. It is a tragedy and a problem, of course. It is a 

long-standing difference. I don’t know how to parse the difference. 

Some of it is educational and other differences, some of it is discrimination. It is hard to say how much. Age and other demographic factors play a role. Unfortunately, this is not something 

monetary policy can do much about. We can only hope to address 

the overall state of the labor market and hope that a rising tide 

will lift all ships, so to speak. But clearly, African Americans remain disadvantaged in education, in wealth creation, and in opportunity. And those are issues that collectively I hope we can address. 

Mr. CLAY. Do you think there is anything that the Federal Reserve, along with Congress, can do to address it? 

Mr. BERNANKE. Again, the Federal Reserve’s monetary policies 

are limited. We have a variety of things that bear on this indirectly, such as our Office of Minority and Women Inclusion, which 

tries to help ensure that in our own employment, we have full diversity. Financial literacy programs that try to help people in 

lower- to moderate-income communities achieve a better level of 

savings and wealth. But more broadly, I think to really address 

these questions, issues of mobility and education, skills, et cetera, 

are more a function of congressional and State and local efforts 

than the Federal Reserve. 

Mr. CLAY. Thank you for your response. Can the Federal Reserve 

institute a monetary policy that is strong enough to avoid a doubledip recession? 

Mr. BERNANKE. At this point, we don’t see a double-dip recession, 

we see continued moderate growth. But we are very committed to 

ensuring, or at least doing all we can to ensure that we continue 

to make progress on the employment side. And we have stated that 

we are prepared to take action as needed to try to make sure that 

we see continued progress on employment. 

Mr. CLAY. In another area of the economy, how will the Federal 

Reserve expansion of asset rates for stimulating the economy sucVerDate Nov 24 2008 18:12 Mar 21, 2013 Jkt 076116 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 K:\DOCS\76116.TXT TERRI
17 

ceed when many individuals have liquid assets that may lose 

value? 

Mr. BERNANKE. You are talking about various monetary policies 

of the FOMC? 

Mr. CLAY. Yes. 

Mr. BERNANKE. Our monetary policies actually generally increase 

asset values, broadly speaking. The concern has been raised, and 

I fully understand it and sympathize with it, that low interest 

rates penalize people who live off the interest earnings of their investments or their savings. And again, I fully appreciate that concern. My response, at least in part, is that if we are going to have 

good returns on savings and investment overall, we need a healthy 

economy. And if we raise interest rates prematurely and cause the 

economy to go into recession, that is not going to be an environment where people can make a good return on their retirement 

funds or their other investments. 

Mr. CLAY. If the United States were to announce it was moving 

to a gold standard, what would you expect to happen to the price 

of gold? And how difficult would that make it for the country to fix 

the value of currency in terms of the price of gold? 

Mr. BERNANKE. That is a very complex question. I think there is 

an issue about whether, at least at current prices, there would be 

enough gold to set up a global gold standard. But there are more 

fundamental issues with the gold standard than that which I have 

addressed on other occasions. And in particular, a gold standard 

doesn’t imply stability in the prices of the goods and services that 

people buy every day. It implies a stability in the price of gold 

itself. 

Mr. CLAY. Thank you for your response. I yield back. 

Chairman BACHUS. Thank you. Let me advise the Republicans on 

the committee that Mr. Hensarling and Mr. Jones, because of the 

questioning lineup, go first, and then under the Greenspan rules, 

Mr. Manzullo and Mr. Fincher, if they are here. And then, we will 

resume with Mr. Royce. So at this time, I recognize Mr. 

Hensarling, the vice chairman. 

Mr. HENSARLING. Thank you, Mr. Chairman. Good morning, 

Chairman Bernanke. You are clearly here before us because of your 

dual mandate. And speaking of maximizing employment, clearly 

the Fed took a number of dramatic actions in 2008, some of which 

I consider proper, some of which I still question. 2008 was 4 years 

ago. I think it is an inescapable conclusion that we have seen the 

greatest monetary and fiscal stimulus thrown at an economy in our 

history, and what do we see but 41 months of 8 percent-plus unemployment, 14.9 percent real unemployment, if we look at those who 

have left the labor force and those who are seeking full-time employment. We have anemic GDP growth, probably half of what it 

should be by historic standards. And my interpretation of your testimony is you are predicting much of the same. Why shouldn’t the 

American people come to the inescapable conclusion that we have 

either had a profound failure of monetary policy or a profound failure of fiscal policy, and which is it? 

Mr. BERNANKE. I don’t think it is the case that there has been 

no progress. In the last quarter of 2008 and the first quarter of 

2009, we almost had a collapse in the economy, a tremendous inVerDate Nov 24 2008 18:12 Mar 21, 2013 Jkt 076116 PO 00000 Frm 00021 Fmt 6633 Sfmt 6633 K:\DOCS\76116.TXT TERRI
18 

crease in unemployment. The unemployment rate went about 10 

percent. Now, it is true that the recovery has been slower than we 

would have liked. But clearly, we have made progress in unemployment and in job creation. 

Mr. HENSARLING. Isn’t it true that if you look at the 10 post-war 

recessions, we are in the midst of the slowest, weakest recovery of 

all? 

Mr. BERNANKE. There is some evidence that financial crises lead 

to recessions that are slower to mend. We also had a housing boom 

and bust, which is also a major factor. So there have been a number of reasons that are consistent with historical experience why 

the recovery should be slower than average. 

Mr. HENSARLING. Okay, let me move on since you don’t agree 

with the premise of that question. You at least acknowledged in the 

question from the gentleman from Missouri, I think you used the 

phrase, there are limits to what monetary policy can achieve. I 

would like to explore those limits for a moment. 

Again, when I look at QE1, QE2, I think we are in our second 

Operation Twist—and, again, I think it is hard to conclude that we 

have—that, again, we have seen the greatest monetary stimulus in 

the history of the country. Obviously, you have a rather unique balance sheet today with asset-backed securities. And, yet, your new 

data reveals that public companies are sitting on $1.7 trillion of excess liquidity, banks have $1.5 trillion in excess reserves. 

And so I am trying to figure out, what is it that—on the Federal 

Reserve menu, what would two more Operation Twists and two 

more QEs, even if you supersized them, achieved that haven’t already been achieved? 

Mr. BERNANKE. First, I think that the previous efforts did have 

productive effects. QE1, for example, was followed a few months 

later by the beginning the recovery in the middle of 2009. And QE2 

came at a time when we were seeing increased risk of deflation, 

which was eliminated by the QE2— 

Mr. HENSARLING. Then why is all this capital, Mr. Chairman, sitting on the sidelines? And you putting in more to excess reserves, 

how is that improving our economy? 

Mr. BERNANKE. The excess reserves are not the issue. The issue 

is the state of financial conditions. And we are still able to lower 

interest rates, improve, broadly speaking, asset prices, and that 

provides some incentive. 

Now, if I might— 

Mr. HENSARLING. Are we not essentially in a negative real interest rate environment already? 

Mr. BERNANKE. Let me just agree with you on the following, that 

monetary policy is not a panacea, it is not the ideal tool. Part of 

the problem is that we hit the zero lower bound, so we can’t use 

the usual practice of cutting short-term interest rates. So I would 

like to see other parts of the government— 

Mr. HENSARLING. In the very limited time I have, Mr. Chairman, 

I have to tell you, when I am speaking to either Fortune 50 CEOs, 

world-class investors, small business people in east Texas, here is 

what I hear: number one, uncertain Federal regulation and certainly harmful Federal regulation is crushing jobs; number two, the 

threatened single largest tax increase in U.S. history; number 

19 

three, a Nation on the road to bankruptcy; and number four, rhetoric out of this President that vilifies success in the free enterprise 

system. And monetary policy is not going to solve that problem. 

Chairman BACHUS. Thank you. 

Mr. Capuano? 

Mr. CAPUANO. Thank you, Mr. Chairman. 

Chairman Bernanke, first of all, I want to thank you for your 

steadfast commitment to taking action as you deem appropriate. I 

am not any different than anybody else; I haven’t agreed with everything you have done. But—and today is another day of it, where 

everybody gets to criticize everything you have ever done for the 

last 10 years. And I may take my shot here or there, but I just 

want to say thank you for not giving up, thank you for not withering under this. We still need you and the Fed to be actively involved, even if there are things you do with which I disagree. 

There are so many things I would like to talk about, but in 5 

minutes, I can’t do it. So I think I am going to talk a little bit first 

about the Libor situation. 

For me—and I am not asking for a decision. I know it is not technically some of the things you are—but one of the things I have 

heard from the fiscal crisis of 2008 is that so many people walked 

away scot-free, that the general public thinks that we, the whole 

government, turned our back on any potential wrongdoing. 

And in this particular situation, if it turns up that our largest 

banks in the world repeatedly, intentionally lied in order to manipulate the market, do you think it is appropriate for them to be held 

accountable? 

Mr. BERNANKE. Of course. 

Mr. CAPUANO. Either civilly or criminally, whatever might be— 

and I am not asking you to make a judgment, but— 

Mr. BERNANKE. Let me just— 

Mr. CAPUANO. —if others make a determination that is appropriate, would you think that is an appropriate— 

Mr. BERNANKE. Currently, there are any number of enforcement 

agencies, including the Department of Justice, the CFTC, the SEC, 

and foreign and State regulators looking at this, and I am sure 

that they will apply the law appropriately. 

Mr. CAPUANO. Because I would appreciate and I think the American people would appreciate it very much if somebody who intentionally lied to manipulate a worldwide market on something that 

affects every one of our daily lives will be held accountable. 

I want to shift a little bit to the fiscal cliff item. And, again, I 

am not asking you to tell us what to do. I respect the difference 

of opinion. But this whole fiscal cliff thing is revolving around, give 

or take, $450 billion, $500 billion that will be shifted around, give 

or take, January of next year. That is round numbers, round dates. 

Five hundred billion dollars—the Fed itself changed the fiscal situation in this country for over a trillion dollars in a matter of less 

than a year between 2000 and 2008. And to suggest that $500 billion in an economy that is $15 trillion is going to change the dynamics of the world, I think it is a little concerning to me. 

But I guess I would like to ask, if it is not going to be $450 billion, $500 billion—and I am not asking you to tell me whether it 

should be tax cuts or spending cuts—what is a number, do you 

20 

think, a general number—to me, that looks like approximately 3 

percent of the economy. I think you said 5 percent. Whatever the 

number is, what do you think is an acceptable number either in tax 

cuts or tax increases or spending cuts to shift? 

Because we are not going to maintain the status quo. We are 

going to do something. That something may, of course, be the reaction of doing nothing. But something will change. And I am just 

wondering, what is a number that you think will not dramatically 

throw us off this cliff? 

Mr. BERNANKE. First, the Federal Reserve’s actions are buying 

and selling securities, not spending and taxing. They are very different. 

The CBO says that the fiscal cliff is on the order of 4 to 5 percent 

of GDP, and that big a shift would have a significant effect on real 

activity in employment. So I am in favor of an aggressive plan over 

a period of time. The $4 trillion number gets tossed around sometimes over the next decade; I am in favor of that. 

And I can’t give you a specific number for the short term, but I 

think there ought to be a more gradual approach. I am not saying 

that you shouldn’t consolidate the budget; I just don’t want it all 

to happen on 1 day, essentially. 

Mr. CAPUANO. As I understand this, it may happen in 1 day, but 

it won’t impact in 1 day, like everything else. Federal spending 

doesn’t end that day; we have obligations that we have to continue. 

Sequestration cuts aren’t going to happen like that. Tax increases, 

I don’t all of a sudden give the Federal Government $3,000 more 

that day; it is a slow, gradual item over a year. 

So I think that some of the fiscal cliff thing really needs a dose 

of reality. I am asking you this because, up until now, I have seen 

you as a person of reality and a conservative approach toward the 

real impact of whatever we do. 

Mr. BERNANKE. The CBO estimates that it would cost 11⁄4 million 

jobs next year, and I don’t think that is an unreasonable estimate. 

Mr. CAPUANO. Oh, no, I understand. I have read the CBO report. 

I know exactly what they say. At the same time, the CBO is one 

source, and you are another. You are not telling me you fully embrace everything the CBO says in that report? 

Mr. BERNANKE. I am just saying that order of magnitude, in 

terms of jobs and GDP, seems reasonable to me. 

Mr. CAPUANO. I don’t think everybody would like that, but there 

is a serious question. See, I would argue with the CBO report on 

other issues, but they are not here today; you are. 

It is unrealistic to think that nothing is going to happen. Either 

we are going to do nothing, which will mean tax increases, which 

will mean massive spending cuts, or we will do something. We 

probably will not do everything; probably not kick the ball down 

the road and just extend all of the tax cuts and get rid of sequestration altogether. We are going to do something in the middle. 

The question is, what is in the middle that is a reasonable number? 

Chairman BACHUS. Thank you. 

Mr. CAPUANO. I am not looking to jeopardize the economy, and— 

Chairman BACHUS. Thank you, Mr. Capuano. 

Mr. CAPUANO. —I guess I am just looking for some guidance. 

21 

Mr. BERNANKE. I don’t have a magic number. I just think you 

should take a smoother approach to obtaining fiscal sustainable. 

Chairman BACHUS. Thank you. 

Mr. Jones? 

Mr. JONES. Mr. Chairman, thank you very much. 

And, Chairman Bernanke, thank you for being here. 

I want to say, two of my worst votes in 18 years were the Iraq 

war—we didn’t have to go to Iraq—and the repeal of GlassSteagall. And if I was not going to yield my time, I would ask you 

about reinstating Glass-Steagall. I think I will write you a letter 

with that question, sir. 

But at this time, because he is one of my dearest friends and I 

supported him for the Republican nomination to be President of the 

United States, I yield my time to Dr. Ron Paul. 

Dr. PAUL. I thank the gentleman from North Carolina. 

I wanted to make a very brief statement about our previous discussion about the Audit the Fed bill. That bill has nothing to do 

with transferring who does monetary policy. It is strictly a transparency bill. Monetary policy reform, I believe, will come, but that 

is another subject. This is just to know more about what the Federal Reserve is doing. 

Mr. Chairman, one of your key points that you have made 

through your academic career as well as being at the Fed has been 

the need to prevent deflation. Would you agree with that? 

Mr. BERNANKE. Generally, yes, sir. 

Dr. PAUL. Right. And you argue that the depression was prolonged by the Federal Reserve not being able to reinflate. So, in 

that sense, I think you really have achieved—you have had the 

chance—you were put in a situation that you alone didn’t create. 

It is, as far as I am concerned, the system created it and other 

managers helped create this. And there was this, what I see as a 

natural tendency to deflate and liquidate and clear the market. 

And under your philosophy, you say we can’t allow this to happen, 

we have to prevent it. And I would say you have done a pretty good 

job. The monetary base has been tripled, and in the last 12 months 

I think M1 has grown about 16 percent, M2 over 9 percent. So it 

seems to be like the monetary system, the monetary numbers are 

still growing. 

But the pricing houses—everybody knows there is a bubble. I 

like to believe that the free-market economists knew about it and 

other predicted it; others did not. But the prices soared up, everybody knows there was a bubble, and then they collapsed. When 

those prices of houses collapse, do you call that deflation? 

Mr. BERNANKE. No. Deflation is the price of current goods and 

services. So, inflation doesn’t capture house prices. It includes the 

house or the rental— 

Dr. PAUL. Okay. And I think one of the problems even getting 

a full-fledged discussion out is sometimes the definition of words, 

about what ‘‘inflation’’ and ‘‘deflation’’ means. Because as far as I 

am concerned, deflation is when the money supply shrinks, and inflation is when the money supply expands. But just about everybody in the country, especially the financial markets, and the way 

I think the conventional use of inflation is the CPI. And I think it 

is a lousy measurement. Because if it is the money supply increase, 

22 

if prices going down of houses is not deflation, I wonder why it is 

that inflation is measured by the CPI going up rather than the 

money supply going up. 

Our argument is that once you distort interest rates and increase 

the supply of money, you end up with this gross distortion that is 

demanding some correction. So I would—I have worked on this for 

years, and we are not going to solve it today. The definitions would 

be much better if we—if prices of houses going down is not deflation, then CPI going up shouldn’t be inflation. 

But we have had trouble for 5 years. The monetary system, you 

say this is not the be-all and end-all. You can’t solve every problem 

with monetary policy. We have had this for 5 years, and we are 

still in a mess. 

Is there ever a time—let’s say we go 5 more years and we have 

the same problems but much worse—you might say, I have to reassess my philosophy on monetary policy, or do you think it will be 

the same no matter what kind of crisis? Can you foresee any kind 

of problem that we would have that would cause you to reassess 

your assumptions? 

Mr. BERNANKE. I can’t conjecture what specifically, but of course, 

yes. I am evidence-based; I look and see what happens and try to 

draw conclusions from that. Certainly. 

Dr. PAUL. The definitions, obviously, to me are very, very important. And if we don’t come to this conclusion and we use these 

terms—inflation demands corrections, and the market wants to correct. So this is why we believe that we are going to have perpetual 

doldrums and finally have a big one. 

Do you consider this recession that we are facing today something that is significantly different since 1945? Much worse and 

different in any way? 

Mr. BERNANKE. Yes, because of the financial crisis, yes. 

Mr. FRANK. Regular order. 

Chairman BACHUS. Thank you. Thank you, Dr. Paul. That was 

a double dose you got. So that was pleasantly unexpected, I guess. 

Mr. Miller? 

Mr. MILLER OF NORTH CAROLINA. Thank you, Mr. Chairman. 

Chairman Bernanke, Mr. Capuano has already asked you about 

the need for accountability if Libor was, in fact, systematically 

gamed. But we frequently hear, with respect to whatever the latest 

scandal is and certainly with respect to the conduct that led up to 

the financial crisis, that the conduct might have been unethical, it 

might be objectionable, but it probably wasn’t illegal, it certainly 

wasn’t criminal, and that the fault was with Congress in not passing tougher laws, for having passed weak laws. 

And I have no stake in defending the laws passed by Congress 

before I got here, but I have read the transcript of the telephone 

conversation between an employee of the New York Fed and the 

Barclays trader, and I have examined the criminal fraud statutes. 

Several transcripts show that Barclays admitted they were filing 

false reports. They were not filing an honest interest rate. But one 

transcript sort of set out why. They said that the Financial Times 

had done a chart that showed that Barclays was consistently paying a higher rate. Folks thought that meant that the other banks 

knew something about Barclays that was not generally known. And 

23 

Barclays’ stock went down, their shares went down. And he said 

that was why they were not filing an honest rate. They were filing 

a rate that would be kind of like everybody else’s, so that it 

wouldn’t call attention to them, like the attention that the Financial Times had called to them, and it wouldn’t affect their shares. 

The definition of fraud appears to be willful intent—providing 

false information with the willful intent to deceive. It can be words 

or acts or the suppression of material facts, again, with intent to 

deceive. A material fact is one that someone, a shareholder or an 

investor, would attach importance to in determining whether or not 

to sell and in determining the price at which to sell those shares. 

With respect to the Barclays shares, presumably the traders and 

many Barclays executives held a substantial number of Barclays 

shares. They probably had options to buy Barclays shares. They 

probably were paid bonuses in Barclays shares. So it appears that 

Barclays was providing information they knew to be false. They 

were providing information that they knew would affect the share 

price. They provided it with the intent of affecting the share price. 

And they personally benefited from the effect on the share price of 

having provided false information. 

What is missing there? What does Congress need to do? If that 

does not meet the definition of criminal fraud, how does Congress 

need to change the law? 

Mr. BERNANKE. I would recommend—the Federal Reserve is not 

an enforcement agency. This is currently under the purview of the 

Department of Justice— 

Mr. MILLER OF NORTH CAROLINA. Right. 

Mr. BERNANKE. —and other enforcement agencies. 

Mr. MILLER OF NORTH CAROLINA. But at the time of those— 

Mervyn King, the Governor of the Bank of England, and Secretary 

Geithner are now in a dispute over exactly what Secretary 

Geithner told him. But there doesn’t seem to be any dispute that 

there was no referral to a U.S. Attorney for criminal prosecution. 

Why was there not a referral for criminal prosecution? 

Mr. BERNANKE. As I understood, what the information came 

across was not quite as explicit as you characterized. It was more, 

sort of, market chatter about— 

Mr. MILLER OF NORTH CAROLINA. No. That is directly from the 

transcript of a conversation between a Barclays employee, a 

Barclays trader, and an employee of the New York Federal Reserve. 

Mr. BERNANKE. The Barclays trader was based in New York and 

was talking about rumors and things that he had heard. He didn’t 

have explicit information. 

But the point, the real point, the relevant point and the important point is that the Federal Reserve Bank of New York did inform the appropriate authorities, and it briefed all of the financial 

regulators, who, in turn, undertook investigations which began 

about the same time, including especially the CFTC investigation. 

Mr. MILLER OF NORTH CAROLINA. You said yesterday that you 

did not know, that no one at the Federal Reserve, the New York 

Fed knew the reports that Barclays was filing false information to 

affect the Libor rate because it affected their derivative positions, 

presumably interest rate swaps. There are many reports that there 

24 

are many banks under investigation. Obviously, that conduct would 

be much more effective if it was done in concert rather than independently. But it wouldn’t make sense to act in concert and it 

wouldn’t really be effective independently if their derivatives position were all over the place. 

Is there examination now into whether the derivatives positions, 

the interest rate swap positions of the various Libor banks, in fact, 

moved in concert? 

Mr. BERNANKE. The CFTC is looking at that kind of issue. That 

is not under our jurisdiction. The investigations from other agencies are addressing those questions. 

Chairman BACHUS. Thank you. 

Mr. Manzullo? 

Mr. MANZULLO. Thank you for coming, Chairman Bernanke. 

What role does uncertainty in the marketplace have to do with 

our financial recovery? 

Mr. BERNANKE. I think uncertainty is—as I have mentioned once 

or twice in this venue, my Ph.D. thesis was about the effects of uncertainty on investment decisions and suggested that it would impede decisions that would be hard to reverse later when information became available. 

So I am sure uncertainty is playing some role. I think where 

there is some disagreement is on the relative weights of different 

kinds of uncertainty. No doubt, regulatory and tax uncertainty are 

part of the broad set of issues that are concerning investors and entrepreneurs. We hear that a lot in our anecdotes. There is also, 

though, general uncertainty about the recovery itself. Will the recovery be sustained or not? In order to be confident about hiring 

people, for example, you like to have greater confidence that, in 

fact, your sales will be— 

Mr. MANZULLO. What you are hearing is also what I am hearing. 

But I am also hearing from a lot of small business people who have 

around 50 people that they are going to fire people to get below 50 

so they are not covered by the President’s health care. I could tell 

you story after story of small manufacturing facilities that are— 

they are going to fire people because they are not going to tolerate 

having to put up with the Affordable Health Care Act. And even 

one major employer back home in Rockford, Illinois, simply told his 

employees, ‘‘I am going to offer you no more health care. I will pay 

the $2,000 fine because I am well over 50.’’ 

Those businesspeople have money. Large corporations have 

money. And have you heard about the uncertainty out there with 

the businesspeople over the President’s Affordable Health Care Act 

and the impact that that has on the recovery? 

Mr. BERNANKE. We get lots of anecdotes. The Reserve Bank 

Presidents from around the country come to the meeting and talk 

about what they are hearing from their contacts, and contacts frequently cite various kinds of uncertainty, including regulatory uncertainty. As I said, though, it is hard to judge whether there is 

a small factor or a large factor. 

Mr. MANZULLO. From what I can tell, it is a very large factor. 

I spend most of my time in this place working on manufacturing 

issues. And couple that uncertainty with the weak orders coming 

from the EU, which I think is our second-largest trading partner 

25 

besides Canada, and the Institute for Supply Management is now 

below 50. It dropped, I think, a dramatic 6 points just in 1 month. 

If the manufacturing sector isn’t going to lead the recovery, what 

will? 

Mr. BERNANKE. I noted in my remarks that manufacturing seems 

to have slowed somewhat. And part of it is the global economic situation— 

Mr. MANZULLO. Demand. 

Mr. BERNANKE. —demand, slowing in European and Asia. And 

that was part of my earlier point. There are multiple factors involved here. 

One sector which is doing a little better is housing, and over time 

that will be a contributing factor. But it is true, as Mr. Hensarling 

pointed out, for example, that growth has been slow, and part of 

the reason is that following a financial crisis, some of the factors 

that normally lead to a strong recovery, like a housing recovery or 

extension of credit, have been affected to some extent by— 

Mr. MANZULLO. What I have been seeing is that those manufacturers involved in mining, oil, and gas exploration, anything dealing with energy, they are actually expanding because they see the 

need for that. And banks are lending based upon that. But the 

massive uncertainty in the manufacturing sector, the fact that companies are unwilling to make decisions is, as you said, 

compounding everything. 

I met with a bunch of European Union parliamentarians yesterday. They believe—of course, it is in their best interest to say so, 

but I really believe that they think that things are stabilizing in 

Europe. Your opinion of that? 

Mr. BERNANKE. I don’t think they are close to having a long-term 

solution that will solve the problem. And until they find those longterm solutions, we are going to continue to see periods of financial 

market volatility, I think. 

Mr. MANZULLO. Okay. Thank you. 

I yield back. 

Chairman BACHUS. Mr. Scott, I guess. No— 

Mr. SCOTT. Thank you, Mr. Chairman. I want to— 

Chairman BACHUS. —Mr. Carson. I am sorry. 

Mr. Carson? 

Mr. CARSON. Thank you, Mr. Chairman. 

Chairman Bernanke, in previous testimony before this committee, you have mentioned that one of the best ways to strengthen 

our labor force is to improve the quality of education, especially in 

disadvantaged areas suffering from persistent unemployment and 

underemployment. 

Some encouraging news that I found in the new monetary report 

is that consumer debt has shrunk. It is not clear to me whether 

our U.S. savings rate is increasing in proportion to the decrease in 

consumer debt. But I am very interested in your assessment on the 

role of financial education, particularly for young people and especially students. The disturbing aspect to me of current consumer 

debt is the alarming increase of student loan debt. 

Do you believe, sir, that investments in financial education can 

help strengthen our economy? And are there any successful models 

or programs that you see as being effective in this area? 

26 

Mr. BERNANKE. The Federal Reserve is very committed to financial education and economic education more generally. I mentioned 

yesterday that I am, later this summer, going to meet, on video, 

with teachers from all over the country who are doing financial 

education to talk about different approaches and the value of that. 

It is clearly very important. The crisis showed that many people 

made bad financial decisions, and that hurt not only them but also 

hurt the broader economy. So it is extremely important. At the 

same time, I think on the other side of the ledger it is important 

that we make sure that financial information, such as credit card 

statements and the like are understandable, that they are not full 

of legalese and small print and those kinds of things. So there are 

really two sides to it. 

So, yes, that is very important. There is still a lot of work going 

on about trying to figure out what works in financial education, 

and I would say that the record is mixed. One of the things that 

we have learned, I think, is that financial education should be introduced in school, in high schools and so on, but it is also important to have a lifelong opportunity. And many folks don’t pay much 

attention to these issues until the time comes for them to buy a 

house or make some other big financial decision, and that is when 

they are most likely to listen carefully and absorb those lessons. 

Mr. CARSON. Thank you, sir. 

I yield back. 

Chairman BACHUS. Thank you. 

Mr. Fincher for 5 minutes. 

Mr. FINCHER. Thank you, Mr. Chairman. 

Privileges to the lowest-ranking Member, myself: I am close to 

the action. So thank you for coming in today. 

To the chairman’s opening question, Chairman Bernanke, about 

auditing the Fed, none of us are challenging—I am not challenging 

the transparency that you have given to us in seeing what is happening. But moving forward to the future, not the past, the ranking 

member’s opening comments about playing politics, most of—I 

know the freshman class, we are not here to play politics. This is 

about trying to prevent—or hopefully build a better America than 

we have now. And auditing the Fed, to most of the American people, seems like something that is responsible if the political games 

wouldn’t be played. 

Can you just kind of comment? Are you that opposed to auditing 

the Fed? 

Mr. BERNANKE. Very much so, because I think the term ‘‘audit 

the Fed’’ is deceptive. The public thinks that auditing means checking the books, looking at the financial statements, making sure 

that you are not doing special deals and that kind of thing. All of 

those things are completely open. The GAO has complete ability to 

address all the things we did during the crisis. All of our books are 

audited by an outside, private—Deloitte & Touche, a private auditor. We have an Inspector General. If there is anything that Congress wants to know about our financial operations, all they have 

to do is say so. 

The one thing which I consider to be absolutely critical, though, 

about the bill is that it would eliminate the exemption for monetary policy in deliberations. And the nightmare scenario I have is 

27 

one in which some future Fed Chairman would decide, say, to raise 

the Federal funds rates by 25 basis points, and somebody in this 

room would say, ‘‘I don’t like that decision. I want the GAO to go 

in and get all the records, get all the transcripts, get all the preparatory materials, and give us an independent opinion on whether 

or not that was the right decision.’’ 

And I think that would have a chilling effect and would prevent 

the Fed from operating on the apolitical, independent basis that is 

so important and which experience shows is much more likely to 

lead to a low-inflation, healthy-currency kind of economy. 

Mr. FINCHER. Is there anything that could be done, any kind of 

compromise, in your opinion, that needs to be done, any more than 

it is being done now? 

Mr. BERNANKE. I think everything in the bill is basically fine except for getting rid of this exemption for monetary policy deliberations and operations. I think that is the part that is critical. And 

it has nothing to do with our books. That is the thing I hope to convey. 

Mr. FINCHER. Okay. 

The second question: Since the financial crisis of 2008, the Federal Reserve has put into play several measures to help stimulate 

an economic recovery, like quantitative easing, Operation Twist, et 

cetera. Do you see these measures as temporary solutions to stimulating the economy, or would the Federal Reserve continue these 

measures on a more permanent basis? 

Some of us fear that we are just dumping tons of money into the 

economy, and that sooner or later, with the low interest rates, that 

things are really going to spin out of control when we do have a 

recovery. 

Mr. BERNANKE. They are, of course, temporary. 

The economy grows in the long run because of all kinds of fundamental factors: the skills of the workforce, the quality of the infrastructure, how effective the tax system is, research and development, all of those things. Monetary policy can’t do much about 

longer-term growth. 

Mr. FINCHER. Right. 

Mr. BERNANKE. All we can try to do is try to smooth out periods 

where the economy is depressed because of lack of demand. And because of the financial crisis, the economy has been slow to reach 

back to its potential, and we are trying to provide additional support so the recovery can bring the economy back to its potential. 

But in the medium- and long-term, monetary policy can’t do anything to make the economy healthier or grow faster except to keep 

inflation low, which we are committed to doing. Things like education, infrastructure, R&D, Tax Code, all those things, obviously, 

are the private sector and Congress, not the Federal Reserve. 

Mr. FINCHER. Do you fear—last question—that when the economy starts to turn and move—and it is going to move, hopefully 

when Washington can add certainty and stability and give confidence back to the American people that we are not going to mess 

things up—there is so much money out there, that this thing is 

going to really go and inflation is going to be a huge problem? 

Mr. BERNANKE. No, it will not. We know how to reverse what we 

did. We know how to take the money out of the system. We know 

28 

how to raise interest rates. So it will be a similar pattern to what 

we have seen in previous episodes where the Fed cut rates, provided support for the recovery, and then when the economy reached 

a point of takeoff where it could support itself on its own, then the 

Fed pulled back, took away the punchbowl. And we can do that and 

we will do that when the time comes. 

Mr. FINCHER. Thank you, Chairman Bernanke. 

Chairman BACHUS. Mr. Himes for 5 minutes. 

Mr. HIMES. Thank you, Mr. Chairman. 

And, Chairman Bernanke, thank you for being with us, and 

thank you for your efforts and work over the course of the last several years to stabilize our economy. 

Mr. Chairman, I read very closely and listened to your testimony 

on the things that are holding back our recovery and read that 

monetary policy report here. And I want to just dwell on them for 

a minute or 2. I saw financial strains associated with Europe, stilltight borrowing conditions, the restraining effects of fiscal policy 

and fiscal uncertainty, and the housing market are the four that 

you highlighted. 

Presuming that we are not, in the near term, going to do a lot 

about number one and number four, I want to explore with you 

still-tight borrowing conditions and whether there is anything that 

Congress could do to assist in that. I know you are hesitant to sort 

of make prescriptions to the Congress, and I understand that. But, 

of course, the Federal Reserve has been pretty clear in their message that monetary policy alone is not enough, so I am going to explore that a little bit with you. 

In the report, you say that still-tight borrowing conditions are a 

result of uncertainty in the economic outlook and high unemployment. You did not mention uncertainty associated with Dodd-Frank 

and the rule-writing process and the new regulations. Can I assume from that omission that you, the Federal Reserve, does not 

believe that that regulatory uncertainty is, in fact, a material cause 

of still-tight borrowing conditions? And if it is material, should we 

be doing something about it? 

Mr. BERNANKE. There are a lot of reasons for the problem. Part 

of it is on the demand side, that borrowers are financially impaired 

from the crisis and they are not as creditworthy or as attractive to 

lenders as they were earlier. There are other various factors, including, for example, concerns that banks have about having mortgages put back to them if they go bad, et cetera. So there is a lot 

of conservatism in lending right now, as well. 

I don’t think I would say that there was no effect of financial regulatory policy on any of this. For example, as we try to develop 

rules for mortgage lending, for mortgage securitization, there is 

still uncertainty about what the playing field will look like when 

the private-sector securitization market comes back or if it does 

come back— 

Mr. HIMES. No, no, I understand, Mr. Chairman. I am sorry to 

interrupt, but, again, my question wasn’t was there no effect; it 

was, was it material? I happen to think that the reforms in DoddFrank, many of them are terribly, terribly important, and there are 

obviously things that we will need to change over time. 

29 

I am really, sort of, looking for materiality. Because, frankly, you 

don’t mention it in the report. If you were to say that, no, it is a 

material effect on credit availability, I might rethink my position. 

Mr. BERNANKE. I think it is partly on us, the regulators, more 

than on Congress, in that some of these things have not been resolved one way or the other. A number of people have talked about 

uncertainty. If we can move to provide clarity about how the regulations will be written and so on, I think that will be helpful. 

And I certainly agree that the benefit of financial reform, which 

is to reduce the threat of another financial crisis, is extremely important to take into consideration. 

Mr. HIMES. Thank you. 

The second question: In your second reason for headwinds here, 

‘‘the restraining effects of fiscal policy,’’ I wonder if you could elaborate on what you mean by ‘‘the restraining effects of fiscal policy.’’ 

How is that providing a headwind to our economic recovery? 

Mr. BERNANKE. Broadly speaking, fiscal policy both at the Federal and the State and local level is now contractionary—that is, 

pulling demand out of the system rather than putting it in. And 

you can see that most clearly at the State and local level, where 

tight budgets over the last few years have meant that at the same 

time that we are trying to increase employment in the country as 

a whole, that, of course, many people are being laid off by the State 

and local governments. 

So I am not making a judgment about that. Obviously, they have 

fiscal issues they have to deal with. But it is just a fact that fiscal 

tightening, particularly at the State and local level, has been something of a drag on the recovery in the last few— 

Mr. HIMES. Can I conclude from all that, though, that your 

achieving your mandate of full employment, were we to abide by 

the policies suggested by some in this institution for more severe 

austerity now, can I conclude that if we pursued that policy, it 

would actually not be helpful toward full employment? 

Mr. BERNANKE. Again, what I have been advocating is sort of a 

two-part policy, one which makes strong and credible steps toward 

achieving sustainability over the medium term, over the next decade, while avoiding sharp cliffs and sharp contractions in the near 

term, yes. 

Mr. HIMES. Last question, drawing on your experience as an 

economist: There is all sorts of debate around here about the things 

that we might do—extending safety net programs, unemployment 

insurance, tax cuts, tax cuts for middle-class families, tax cuts for 

the wealthy, infrastructure investment. Each of these things, each 

of these fiscal policies have different multiplier effects, more positive impact on the economy. 

Chairman BACHUS. Okay— 

Mr. HIMES. I wonder if you might just relatively rank the multiplier effects of those four initiatives that I just laid out. 

Mr. BERNANKE. No, I think that would come too close to advocating the different approaches. And each of these things has not 

only multiplier effects but it has different costs, it has different 

benefits to the economy, different philosophies about the size of 

government and so on. So I think, unfortunately, that is a congressional prerogative to figure that out. 

30 

Chairman BACHUS. Thank you. 

Mr. HIMES. Thank you, Mr. Chairman. 

Chairman BACHUS. Mr. Royce for 5 minutes. 

Mr. ROYCE. Thank you. 

Chairman Bernanke, looking out on the horizon, on the long road 

ahead of us, there are two studies that seem to indicate the same 

thing: one recently that came out of the IMF which indicated that 

a 10-percentage-point fall in the debt-to-GDP ratio typically leads 

to output rising by 1.4 percent; and a similar conclusion coming 

from the other direction from Rogoff and Reinhart who say in their 

paper, ‘‘Growth in a Time of Debt,’’ that debt burdens above 90 percent are associated with 1 to 2 percent lower median growth going 

forward. 

Our entitlement obligations will consume all of the average postwar projected tax revenue in a few decades, if we just look at the 

studies that, frankly, you have shared with us. Will we be able to 

see strong sustainable economic growth without addressing our entitlement obligations, which you have labeled ‘‘unsustainable’’ in 

terms of the way they are currently set to compound? 

Mr. BERNANKE. On current law, healthcare expenditures are expected to rise very substantially, to the extent that they would be 

crowding out other parts of the government or, alternatively, requiring significant tax increases. So if you want to avoid those outcomes, it is important to find ways to reduce expenditure. I hope 

that it can be done in ways that don’t involve worse health care 

but just involve a more efficient delivery of health care. 

Mr. ROYCE. Would you like to make any other observations in 

terms of the deficits or the size of the debt as you look 10 years 

out, 15 years out? 

Mr. BERNANKE. Again, the CBO has done many analyses which 

show that our fiscal path is unsustainable, even if we avoid some 

kind of crisis at some point. While I don’t necessarily buy exactly 

into the 90 percent number and so on, I think it is pretty clear that 

a high level of debt to GDP, both because of future tax obligations, 

high interest rates, is going to impede growth, all else equal. 

Mr. ROYCE. And that will impact employment in the future. 

Let me go to another question, regarding Basel III. I think it is 

a step in the right direction, but at the end of the day, capital is 

the ultimate buffer that stands between the taxpayer and the systemically risky institutions, right? So under Basel III, my concern 

is that it continues to rely on internal risk models at financial institutions when you set the capital levels, the requirements there. 

I don’t mind those being used internally for purposes, but to use 

that to set the capital levels—if I may quote your former colleague, 

Alan Blinder, he says that, prior to the crisis, these models were 

gained, is the argument he is making, to avoid raising additional 

capital. And, of course, what that means is that they had excessive 

leverage. 

And if you look at the Basel committee study: ‘‘Capital levels in 

American banks employing the internal ratings approach would experience a capital reduction of 7 to 27 percent. Those adhering to 

the standardized approach typically used by the smaller banks 

would experience a 2 percent increase in capital demands.’’ So we 

31 

have a recent study which found 83 percent of institutional investors want to get rid of model discretion. 

Mr. Chairman, given the history of the gaming of these models 

in setting capital levels, and given that institutional investors are 

demanding to move away from model discretion, are you comfortable with continuing to use these models in setting capital calculations? If you just look at the minimum leverage ratio, are you 

comfortable with that 3 percent level of Tier 1 capital to total assets, or a 33-to-1 total leverage there? 

Mr. BERNANKE. Right. So the overall system has been strengthened quite a bit with the international leverage ratio—more capital, higher-quality capital, buffers, liquidity rules, and so on. So I 

think it is a stronger system. 

Your point is well-taken. For those models to be worthwhile, they 

need to be validated and they need to be good. The Federal Reserve 

and the other regulators don’t just let you use whatever model you 

want; they have to be approved and validated by the regulators. 

And I believe that is an adequate— 

Mr. ROYCE. But the argument I am making is that the only way 

to guarantee that doesn’t happen is to focus on the old-fashioned 

minimum leverage ratio— 

Chairman BACHUS. Thank you. 

Mr. ROYCE. —which, under Basel III, is far too low. 

Chairman BACHUS. Thank you, Mr. Royce. 

Mr. Carney? 

Mr. CARNEY. Thank you, Mr. Chairman. 

Chairman Bernanke, thank you for coming in today. By the time 

you get to me, many of my questions that I have have already been 

addressed. So I would like to just go back to some of the things 

that were in your statement and in your report, just to confirm my 

understanding. 

Since I get it that the Fed is doing everything it can, with respect to monetary policy, to address the employment part of your 

dual mandate—is that correct? 

Mr. BERNANKE. We can continue to evaluate the situation, evaluate the outlook, look at the tools that we have, and we are committed to make sure that we continue to have improvement on employment. But I don’t want to imply that we have done everything 

we can. We may do more in the future. 

Mr. CARNEY. So there is more that you might do? 

Mr. BERNANKE. It is certainly possible that we will take additional action if we conclude that we are not making progress toward higher levels of employment. 

Mr. CARNEY. Thank you. 

And there seems to be little reason for concern on the price stability side at the moment. 

Mr. BERNANKE. For now, inflation seems to be well in check. 

Mr. CARNEY. And you also said that progress has been made in 

terms of the recovery, but unemployment is still too high, and the 

recovery has stalled and is not as strong as maybe you had hoped 

at this point. 

Mr. BERNANKE. The recovery has decelerated recently. It is sort 

of a pattern we have seen for the last few years, that things seem 

to be stronger in the beginning of the year and then the slowdown 

32 

around spring, spring and summer. So we will try to assess whether this is just a temporary slowdown or whether something more 

fundamental is happening. Again, we are committed to doing what 

is necessary to make sure the recovery continues and employment 

continues to grow. 

Mr. CARNEY. At one point, you said that two big risks to economic growth were the European situation and the effects of the 

U.S. fiscal policy, the so-called fiscal cliff. And in part of your response to that, you said that the most effective thing that Congress 

could do would be to address the fiscal cliff. And I think you said 

the sooner we did that, the better. 

What do you mean by that, the sooner we did that, the better? 

Mr. BERNANKE. One of the issues—and this is not explicitly accounted for in the CBO study—is that, even putting aside the effects on activity of the fiscal cliff, as time passes, as we get closer 

to the end of the year, we are likely to see increased uncertainty 

both in financial markets and among people who are making investment and hiring decisions about what programs will be in 

place, which ones will not, what the tax rates will be, and those 

kinds of things. 

Mr. CARNEY. So certainty and confidence are a big part of that, 

right? 

Mr. BERNANKE. Absolutely. 

Mr. CARNEY. And I know—I am going to try not to ask you to 

suggest things that we should be doing, because I know you won’t 

answer those questions. But I would like to ask you once to go back 

to the question that Mr. Capuano left you at, which is really a 

sense of what ‘‘gradual’’ means. Can you describe that numerically 

in some kind of way, as opposed to prescriptively in terms of policy? 

Mr. BERNANKE. I think there is a range that—people would have 

different views about whether you should be more proactive or just 

avoid the cliff. 

Mr. CARNEY. Right, right, right. 

Mr. BERNANKE. There is a range of views there. 

Mr. CARNEY. So when you say more proactive, in terms of maybe 

stimulating? 

Mr. BERNANKE. Some folks would want to do more fiscal activity. 

Mr. CARNEY. Right. 

Mr. BERNANKE. There are different views. What I am taking here 

is a sort of do-no-harm kind of approach and say that you just want 

to avoid the impact of the cliff. 

Mr. CARNEY. Have we learned anything from the European response? Have they taken through the requirements that the 

eurozone have imposed on some of the members’ fiscal policies that 

probably aren’t the best? 

Mr. BERNANKE. I think we have learned that sharp fiscal contractions can slow economic activity. We are seeing that in a number of countries. That is not to say that they have any choice. In 

the case of Greece, for example, they don’t have many options 

about cutting back on their fiscal deficits. But we have seen countries that have very sharply contracted their fiscal positions experiencing recessions at the same time. 

33 

Mr. CARNEY. I only have time for one more question. So, two of 

the big issues that are in our fiscal situation—and you have talked 

about healthcare spending, that is the biggest part on the spending 

side, and of course tax policy. Is certainty more important than the 

underlying policy or as important? 

The Affordable Care Act was intended and will—projections are 

it will reduce costs in the long term but will create a lot of uncertainty in the short term. Similarly on tax policy. I see my time is 

running out. Do you have a thought on that? 

Mr. BERNANKE. Whenever you can have clarity about your policy 

intentions—and this applies to the Federal Reserve, too—it is going 

to be better. 

Mr. CARNEY. Thank you. 

Mr. LUCAS [presiding]. The gentleman’s time has expired. 

The Chair now recognizes himself. 

Mr. Chairman, press reports have indicated—and let’s return to 

Libor for just a moment—that the New York Fed first learned of 

possible rigging of Libor in 2008. However, when the CFTC announced the enforcement action and the $200 million fine against 

Barclays in June, they said the interest rate rigging continued sporadically well into 2009. 

Chairman Bernanke, did anyone at the New York Fed inform the 

Federal Reserve in Washington, D.C., of potential rigging in 2008? 

Mr. BERNANKE. Let me be clear. There are two types of behaviors 

that the CFTC has identified. One is manipulation of the rate by 

derivatives traders for short-term profit. That information has only 

recently come to light; none of that was known in 2008–2009. 

What the Federal Reserve heard about in 2008 had to do with 

banks that were members of the panel, the Libor panel, possibly 

underreporting their borrowing costs in order to avoid appearing 

weak in the market. This was information that was about that 

time becoming generally known. There were media reports in April 

of 2008, for example, talking about widespread chatter in the markets about that kind of behavior. 

So that was understood, and it was understood that part of the 

problem was the structural problems with the Libor system. And 

so, the New York Fed took two kinds of steps. One was to inform 

all the relevant regulators what it had learned. But it also took 

steps to try to make improvements in how Libor is collected and 

calculated. 

Mr. LUCAS. And you can understand the perspective of myself 

and the Agriculture Committee, since literally thousands of those 

derivative contracts, which fall under the jurisdiction of the committee, were settled potentially using those what now appear to be 

rigged rates. The impact is very relevant. 

So can I take your answer to say, therefore, that someone from 

the Federal Reserve did, indeed, tell the CFTC about this potential 

issue in 2008? 

Mr. BERNANKE. Absolutely. As was released in the materials on 

Friday, the New York Fed made presentations to the President’s 

Working Group, which includes the CFTC, the SEC, the Fed, and 

the Treasury. It made separate presentations to the Treasury. And 

it communicated with British authorities about the issues of how 

to strengthen Libor and address this underreporting problem. 

34 

Mr. LUCAS. Thank you, Mr. Chairman. 

And, with that, surprisingly enough, I will yield back the balance 

of my time and recognize the gentlelady from California, Ms. Waters, for 5 minutes. 

Ms. WATERS. Thank you very much. 

Thank you for being here, Chairman Bernanke. There is so much 

all of us would like to discuss. 

As I recall, in the past year since the passage of Dodd-Frank, we 

can see that major U.S. banks have managed to make themselves 

profitable again, but really, the scandals still keep coming, and 

public trust in the integrity of the financial system, I think is at 

an end. That is why I have been advocating for the swift implementation of the Wall Street reform law, strong enforcement of existing 

law, and for adequate funding for our regulators. 

But as I did last week at another hearing of this committee, I 

just want to remind us all, in just the last 2 years we have seen 

the robo-signing of foreclosure documents, the robo-signing of credit 

card judgments, billions of dollars of put-back lawsuits over mortgage-backed securities, the failure of two major Futures Commission merchants, municipal bond bid rigging, alleged energy market 

manipulation, money laundering now for drug cartels, the losses of 

the ‘‘London Whale,’’ and the bungling of the Facebook initial public offering. And this is just a partial list. 

And it is capped off by what might be the most far-reaching scandal of all, Libor manipulation. One commentator, Andrew Lo, a professor at MIT, has noted that this Libor fixing scandal dwarfs by 

orders of magnitude any financial scam in the history of the markets. 

I guess in all of this, let me just ask, as it relates to Libor, what 

are you going to do about primary dealers who we find have been 

involved in manipulating the information in order to look better? 

You have that responsibility; you determine, do you not, who the 

primary dealers are? 

Mr. BERNANKE. We determine who the primary dealers are. We 

don’t necessarily regulate them. 

This particular issue is now under heavy coverage by the CFTC, 

the DOJ, the SEC, and authorities from other countries as well. 

And I am sure that they will follow through with every company 

involved. 

Ms. WATERS. As I understand it, the New York Fed may not regulate primary dealers, but they do set out business standards and 

technical requirements for primary dealers, and they can fire a primary dealer at any time. Are any going to be fired, do you know? 

Mr. BERNANKE. If there are questions raised about the integrity 

and competence of a primary dealer, yes. It could happen, certainly. 

Ms. WATERS. Okay. That is good to know. 

Let me just segue into something that perhaps you had not anticipated. Out in California, we have a number of cities that are filing bankruptcy, and a lot of this has to do with the housing crisis 

and the problems that they have. San Bernardino is one, of course, 

and Stockton, and some time ago, it was Vallejo. 

In San Bernardino, they had some interesting discussions about 

how to use eminent domain in order to keep people in their homes. 

35 

From what I can understand, they would access the properties 

through eminent domain, and then they would pay the fair market 

value. But the fair market value is different than the mortgage 

agreement because they are now underwater. They would keep people in their homes and, of course, try and stabilize the housing. 

But what do you think about that? 

Mr. BERNANKE. I think it raises legal issues that I am just not 

qualified to comment on. It is a very difficult set of problems that 

they are facing, and I am very sympathetic to their attempts to try 

to address it, but whether this is a good vehicle or not, I am not 

qualified to answer the question. 

Ms. WATERS. Do you believe that these cities are taking action 

because they are just basically tired of waiting for us to solve the 

problems of the housing crisis? There is one thing that I think you 

were involved in with the OCC, and it had to do with the mitigation process for dealing with some of the issues of getting information out to some of the people who had been harmed and getting 

them compensated up to $125,000, I do believe, but only 8 percent 

returns? 

Former Chairman Frank and I have met with the OCC, and they 

talked about coming up with new outreach-type programs, et 

cetera. Have you been in discussion with them about what you 

could do to do better outreach and get more people involved and 

responding? 

Mr. BERNANKE. We have. We have been trying really hard, done 

a lot of advertising, Web-based, social-media-type communications. 

We have taken the GAO commentary and tried to incorporate that. 

But, most recently, I understand, we are trying to make a more 

community-based approach to reach out to churches and AfricanAmerican groups and the like and trying to get their assistance as 

well, as well as home mortgage counselors. Yes, we are trying to 

address that. 

Mrs. BIGGERT [presiding]. The gentlelady’s time has expired. 

I recognize myself for 5 minutes. 

Chairman Bernanke, could you just talk a little bit about the differences between insurance and banking, as the Federal Reserve 

looks at it? 

Mr. BERNANKE. Sure. 

For insurance companies that either own a thrift or should one 

become designated as a nonbank systemically important firm, the 

Federal Reserve would have consolidated supervision over those insurance companies’ responsibilities. 

We recognize there are differences between insurance companies 

and banks, so a couple of differences in the way we would manage 

that. One would be, of course, that the insurance companies themselves, the insurance subs, will continue to be, as I understand it, 

will continue to be regulated by the State, State authorities, and 

be subject to the insurance company regulatory and capital requirements. The Federal Reserve will impose capital requirements at 

the holding company level to make sure that overall the company 

is well-capitalized. But even in doing that, we will try to take into 

account differences between insurance companies and other types 

of firms. So, for example, there are certain types of assets that insurance companies have, like not fully guaranteed accounts that 

36 

some of their customers might have, and we are looking to give 

those different capital treatments. 

So there will be a lot of similarities, admittedly, at the holding 

company level, but we recognize insurance companies have both a 

different composition of assets and a different set of liabilities. And 

appropriate regulation needs to take that into account. 

Mrs. BIGGERT. Okay. I think that there have been other Federal 

regulators that have either signaled or taken action to allow State 

insurance regulators to continue to do their job, regulating insurance. 

There is concern, I think, with the Fed plan that, how are you 

going to relate to the companies that maybe have only 1 percent 

or 2 percent of their assets as part of a thrift or a savings and loan, 

when 98 to 99 percent of their assets are in insurance? 

Mr. BERNANKE. As I said, we will try to take into account the differences. Insurance companies have many of the same assets that 

banks do and, therefore, share the credit and market risks that 

banks have. And so, for those kinds of assets, it could be appropriate to have similar capital requirements for insurance companies and banks. 

But in those cases where there are distinctive differences, then 

I think we need to try and accommodate that the best we can, consistent with the Collins Amendment and other rules in DoddFrank. 

Mrs. BIGGERT. That brings up—you have the June 7th 800-page 

proposed capital rules that intend to regulate insurance companies 

as well as the banks. So do you think there will be a good distinction between those two? 

And I am also concerned about the fact that it is a 90-day comment period. Do you think that will be extended for some of these 

companies to have to come in and really— 

Mr. BERNANKE. If the comment period is insufficient to get a full 

response from the public, we certainly can consider extending it. 

Mrs. BIGGERT. Okay. And there is a question then of, do you 

think that the Federal Reserve has the statutory flexibility to recognize the insurance risk-based capital and leverage requirements? 

There is the Collins Amendment, and then there is Dodd-Frank, 

which I think goes through with that. But does the Collins Amendment then prevent a difference? 

Mr. BERNANKE. My understanding, and I will be happy to follow 

up with you on this, is that we have to meet certain requirements 

at the holding company level. So at the holding company level, 

there will be a lot of overlap between the regulation of a bank holding company and a thrift holding company. But again, my understanding is that we will not try to impose bank-style capital requirements on individual insurance subs, and that those can still 

be subject to the State capital requirements. 

Mrs. BIGGERT. Okay. I thank you. The gentlelady from New York 

is recognized for 5 minutes. 

Mrs. MALONEY. Thank you, and thank you for your public service. I would like to note that the Consumer Financial Protection 

Bureau issued its first enforcement action today, ordering a financial institution to pay a fine for what the agency described as deceptive marketing tactics related to credit card products. I wanted 

37 

to publicly thank you for your leadership and this Congress’ leadership on credit card reform, and note that it is good to see that consumers have an agency speaking up and fighting for their protections and financial products. 

The Libor problem, really, is readily solvable if we use a different 

index, one that is objective, public, readily verifiable, and manipulation-resistant by any single bank. So I would like to ask you what 

are your favorite alternatives to Libor? And have you relayed that 

to Mr. King at the Bank of England? And if so, what was his response? 

Mr. BERNANKE. As I discussed yesterday, I think there still are 

problems with the current Libor system because it doesn’t always 

reflect an actual market transaction. And the Federal Reserve 

Bank of New York made some recommendations for reform which 

have not been fully adopted. So one strategy would be to switch to 

a market-based indicator. The Federal Reserve has not come out in 

favor of a specific one. But a number of possibilities include repo 

rates, the so-called OIS index, and even potentially Treasury bill 

rates, for example. 

So there are a number of possible candidates. I have not addressed this issue to Governor King. I have talked to Mark Carney, 

who is the governor of the Bank of Canada, who is the head of the 

Financial Stability Board, which is an international body which 

looks at issues pertaining to regulation and financial stability. And 

that body is going to be looking at the Libor controversy, implications for financial stability, and possible ways to move forward. So 

that will be one international effort to look at alternatives. 

Mrs. MALONEY. Okay. Why is the American economy doing better 

than Europe’s? The Europeans seem to be more focused on debt, 

and working towards austerity, and austerity in their public policy 

instead of stimulating the economy. And what role do you think 

stimulating the economy with monetary stimulus and fiscal stimulus, what role do you think that played in the American recovery, 

which is better so far than the European one? 

Mr. BERNANKE. Yes. The U.S. recovery is somewhat disappointing, of course, but it has been stronger than some other 

areas. In Europe, they are facing a number of challenges, mostly 

related to the structural problems associated with the common currency and with the structure of the eurozone. So a number of factors contributed to the slowdown in the economy. One of them is 

the fact that a number of countries, which are under a lot of pressure from markets, are severely cutting their fiscal positions. And 

that is contributing to the slowing economic activity. But in addition to that, their banking system is having problems, and credit 

has become very tight in some countries. Moreover, all of the issues 

related to the possible default of various countries, or the risks 

borne by financial institutions have led to a lot of volatility in financial markets, which has also been a negative factor. So they 

really are facing a lot of headwinds there, and it is quite a difficult 

situation. 

Mrs. MALONEY. I am especially worried about the efforts of some 

of my colleagues on the other side of the aisle to limit the Fed’s 

ability to use monetary stimulus. Long-term unemployment is really high, and I am worried that we don’t have enough tools to comVerDate Nov 24 2008 18:12 Mar 21, 2013 Jkt 076116 PO 00000 Frm 00041 Fmt 6633 Sfmt 6633 K:\DOCS\76116.TXT TERRI
38 

bat it. And don’t you believe that the long-term unemployment 

would be even higher if the Fed had raised the Federal funds rate 

and not purchased government securities? 

Mr. BERNANKE. I am quite confident of that. We haven’t had the 

recovery we would like, but certainly, monetary policy has contributed to growth and reduction of unemployment in the last 3 years. 

Mrs. MALONEY. And I would like to hear your comments on positive signs that you see in the latest U.S. economic data. 

Mrs. BIGGERT. The gentlelady’s time has expired. 

Mr. BERNANKE. I note housing is one area. 

Mrs. BIGGERT. The gentleman from California, Mr. Miller, is recognized for 5 minutes. 

Mr. MILLER OF CALIFORNIA. Thank you, Madam Chairwoman. 

Welcome back, Chairman Bernanke. It is good to have you here. In 

your testimony, you cited low demand and high inventory for 

houses throughout the country. In California, it is kind of an interesting process. We are kind of going the other way. Inventories 

overall in California are down to about 3.5 months, down from 4.2 

months in May, which is a really good trend. In fact, in the Inland 

Empire, which was hit very, very hard, San Bernardino County, it 

is actually down to about 40 days. 

It is nice to go into a real estate office and actually see lists of 

buyers instead of lists of homes for sale. What do you think we can 

do to keep this trend going? Because I don’t believe the economy 

is going to come back until the housing market recovers. 

Mr. BERNANKE. As you say, there is improvement in the market 

as a whole, and particularly in some areas. I am not sure that this 

low inventory situation will persist, because there is a pretty big 

backlog of houses that are in the foreclosure process that may come 

onto the market. And that will be an issue. 

We provided a working paper earlier this year that discussed 

some of the issues in housing. For example, in order to keep down 

that inventory, one strategy is to undertake programs that convert 

REO, real estate owned by banks and other owners, to rental properties. And the GSEs are running a program like that, which has 

some promise. It is important to do what we can to avoid foreclosure, obviously, where it is possible. Or if that is not possible, 

to give people a way, through deed-in-lieu or short sales or other 

mechanisms, to get out of their home and to sell it and to avoid 

a lengthy process. 

Access to credit remains a very significant problem. It is hard to 

point to specific things that can be done. But one thing I think is 

promising is that the GSEs, as I understand it, are considering 

changes in their practices that will reduce the concerns that banks 

have about so-called put-back risk, so that when banks make a 

mortgage loan and sell the mortgage to Fannie Mae or Freddie 

Mac, there is a substantial risk that if the mortgage goes bad, if 

there is any kind of problem with documentation or anything else, 

that they will get that mortgage back and be liable to the— 

Mr. MILLER OF CALIFORNIA. I like that. 

Mr. BERNANKE. There are a number of areas where we could 

hope to see improvement in the housing market, but unfortunately, 

there is no single solution. And to some extent, just economic recovery more generally is going to drive the housing market. 

39 

Mr. MILLER OF CALIFORNIA. There is a concern about what we 

are doing. FHFA has developed a pilot program with Freddie and 

Fannie to sell their REOs on a bulk sale. You saw that program, 

they are doing a pilot program on it. 

Mr. BERNANKE. That is right. 

Mr. MILLER OF CALIFORNIA. And the problem I have with that 

is they are doing it in the Inland Empire, which has a 40-day supply of homes. When they sent the letter out, there was a group of 

us in our area, 19 of us who represent that region, who wrote a 

letter objecting to it. And they said, well, these houses have been 

on the market. When we saw the data, 70 percent of the homes 

have never even been listed. And my concern is, why would we do 

that? If we bulk sell them, we are going to sell them for less than 

market value. If we sold them in the traditional foreclosure process, you would get more money listing with a REALTOR® and selling them out. But we are actually going to cost the taxpayers 

money starting a pilot program in a part of the country that has 

a very low amount of homes listed. 

Why would we do that? It doesn’t make any sense when we 

should—I agree there are probably some parts of the country where 

maybe there is a high inventory level and you need to bulk sale 

them out. But why would they pick the one area of the country 

that is starting to recover? Maybe it is because the house prices are 

so depressed. But you are bulk selling them out, costing taxpayers 

money. Why would we do that? 

Mr. BERNANKE. I am not sure it is costing taxpayers money. I 

hope not. I think one of the reasons they would be doing that is 

in order to make REO to rental programs work, you want to have 

a large number of houses close together, foreclosed homes close together so that they can be managed by rental— 

Mr. MILLER OF CALIFORNIA. But if you sell them off in bulk, you 

are going to sell them for less than market value, the way they are 

selling them off. 

Mr. BERNANKE. But more quickly and with less cost. 

Mr. MILLER OF CALIFORNIA. But if you have a 40-day supply of 

inventory, my argument is that there are probably places where 7 

months is considered normal. We have a 40-day supply of inventory. And Freddie and Fannie are bulk selling those through FHFA 

at a reduced price, when those houses could be listed and sold. 

Mr. BERNANKE. That is a good point. I hadn’t heard that before. 

And I would urge you to talk to Ed DeMarco about that. 

Mr. MILLER OF CALIFORNIA. I did. And the response from Mr. 

DeMarco was that, ‘‘We are afraid we would lose credibility by not 

selling them now that we have bid them out.’’ And my response 

was, ‘‘I am concerned with losing credibility by costing the taxpayers money selling homes in a region that has no inventory and 

an abundance of buyers.’’ I just think that is something somebody 

should talk about when you are in meetings. 

Mr. BERNANKE. Okay. Thank you. 

Mr. MILLER OF CALIFORNIA. Thank you, sir. 

Mrs. BIGGERT. The gentleman’s time has expired. The gentleman 

from Georgia, Mr. Scott, is recognized for 5 minutes. 

Mr. SCOTT. Thank you very much, Madam Chairwoman, and welcome, Chairman Bernanke. It is good to have you here. I want to 

40 

talk about what I think is the core of our issue now dealing with 

especially unemployment, and that is a very serious paralysis of 

partisanship that has basically hijacked this Congress. And I say 

that because I think that you all have done pretty much what you 

can do. You have reached in the Fed your point of what you call 

zero lower bound, where you can’t go any further with your interest 

rates. 

And everything that we have done here, we talked about, for example, the policies that we made, nowhere is the economy more impacted than health care. The whole issue was the rising costs of 

that. We passed a health care bill. And that bill has a direct impact 

on unemployment and employing people. For example, in there we 

have the Medicaid expansion, which will bring in another 18 million individuals. And most importantly, it will have an extraordinary impact on job creation, maintaining jobs, and other jobs. 

Most critical, you find on basically a partisan basis, already those 

States that have the most to lose, that have the highest rates of 

uninsured and have the highest rates of unemployed are saying 

they are going to turn away billions of dollars in Medicaid that will 

go directly to their largest employers, which are the hospitals. Onethird of all the hospitals in this country are facing closure, which 

means rising unemployment. And so there has to be—what message can you give the Nation and the Congress here on how we can 

get our act together and how devastating this partisanship—just 

we will deny the unemployed, we will deny this in these States 

strictly because of partisanship. How serious is this to this country? 

Mr. BERNANKE. Unemployment is an enormous problem. It represents not only wasted resources; it represents hardship. And 

given the large number of people who have been unemployed for 

6 months or more, there are a lot of people who will never really 

come back to the labor force, or if they do, they will have lost their 

skills and will not be as employable as they were before. So the 

costs are very, very high. The Federal Reserve is, as you say, doing 

our best to try to help the economy recover and put people back 

to work. But monetary policy isn’t a panacea; it doesn’t have all the 

tools that could be used. And so, I would urge Congress to work 

together as much as possible to address this. It is a very serious 

problem. And it is not just a temporary cyclical problem, the longrun unemployed could affect our labor force for many, many years 

because of their loss of skills. 

Mr. SCOTT. Let me get to the other point because I know my time 

is shrinking, thank you very much. But let’s talk about what we 

can do in the future. We have sequestration coming up, for example. How can we formulate our policy dealing with sequestration to 

shorten and lessen the impact on unemployment? Let’s look at defense, for example. We have 50 percent arbitrary we are going to 

cut. Can we not have some indication of how devastating this is 

going to be in employment, particularly with many of our defense 

industries which have huge, huge plants, with huge numbers of 

employees? 

And what impact will sequestration have not just in cutting our 

defense capabilities, but in employment? Can we not have a direction or leadership where we would be very careful as we move forVerDate Nov 24 2008 18:12 Mar 21, 2013 Jkt 076116 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 K:\DOCS\76116.TXT TERRI
41 

ward with sequestration to make sure we have less of an impact 

of how that will put people out of work? 

Mr. BERNANKE. I cited the CBO number of 11⁄4 million jobs from 

the fiscal cliff would be lost, or fewer created than otherwise. So 

there is a big employment implication. On the other hand, it is 

very important not just to forget about the long run, we have to 

make sure we are addressing our long run issues of fiscal sustainability. And so, what I have been recommending is a combination 

of more moderate fiscal retrenchment in the shorter term to respect 

the fragility of the recovery, but combined with serious and credible 

actions, to address fiscal unsustainability in the longer term. 

Mr. SCOTT. And very quickly, the other shoe that we have that 

will drop is the ending of the Bush tax cuts. What is your advice 

on which way we should go in that direction as far as having a 

lessening impact on unemployment? 

Mr. BERNANKE. I can’t advise on specific tax cuts and spending. 

But in looking at the package overall— 

Mrs. BIGGERT. The gentleman’s time has expired. 

Mr. BERNANKE. —I am concerned about the contraction of the entire program. 

Mrs. BIGGERT. The gentleman from New Jersey, Mr. Garrett, is 

recognized for 5 minutes. 

Mr. GARRETT. I thank the chairwoman. So ever since 2009, we 

have been hearing that the Fed is sort of out of bullets. But we 

could also argue that you and your colleagues have been pulling 

the trigger quite a bit since that time, whether it is with 3 rounds 

of quantitative easing, with 6 years of interest rates being almost 

0 percent, balance sheet still stands almost triple its normal size. 

It is obviously safe to say that we have been, we are, and we continue to be in uncharted territory. Now, through all this, you normally come and you defend yourself on these policy decisions by arguing the counterfactual, that is to say, that things could have 

been a lot worse had we not taken these actions. But before we go 

down that line of argument, or discussion, you have to think about 

where things really are. 

With the recent decline in interest rates where we are in the 

market today, is that the result of what the Fed is doing or is that 

the result of the marketplace? The real return out there on a 10- 

year Treasury is roughly negative 5 percent, right? Is that a function of the Fed’s action keeping the rates down or is that a function 

of the market in general? And if it is an action in response to the 

Fed, then the question would be, what is the appropriate rate that 

we should have in the market? And if the appropriate rate is where 

the Fed is trying to keep it and where you have said you are going 

to keep it for the next foreseeable future, the next couple of years, 

down near zero, isn’t that actually discouraging investment by individuals and businesses at the same time? 

If I know as a businessman or individual that the interest rates 

are going to be this low for this year and next year and beyond, 

maybe I put off those investment decisions to a later date. So some 

of these decisions may actually have a negative side to them. In 

other words, maybe there is a counterfactual to your counterfactual. Maybe there is a risk inherent in the policies that you have 

taken. And I will close on this: The Fed involves itself all across 

42 

the economy. You fix the Fed’s fund rate; you manipulate the yield 

curve via Operation Twist; you essentially monetize our national 

debt; you manipulate the mortgage market along with every other 

part of the credit market via quantitative easing; you attempt to 

manipulate the stock market and the prices there through the portfolio balance channel; you involve yourself in every aspect of the 

economy. 

There is not a price in the marketplace that is not subsidized in 

one sense or another by the Fed. Yesterday at the hearing—I listened to the tape of the hearing—you said you had more bullets 

that you could pull. You said that there is a range of possibilities, 

buying Treasuries, MBS, using a discount window, employing additional communication tools, commit to holding rates below even 

through 2015 or beyond, cutting the rate the Fed pays on excess 

reserves. So these are all additional bullets that continue to push 

us into uncharted territory. 

What I would ask is, is the Fed being as transparent in all these 

things in going forward on the downside of all these, on the downside of accommodation? Particularly, what I would say is the failed 

accommodation. How does QE3 create a single job? Yes, it props up 

the commodity markets; yes, that is great for those in the commodity market area. But if I am on the other side of that trade, 

if I am the individual like an airline that is buying these commodities, I may be laying off people. Is there enough transparency in 

that area to say what the downsides are in the failed portions of 

your policies? 

Mr. BERNANKE. Some years ago, we provided research that 

showed, based on models and analysis, how easing financial conditions, lowering interest rates—and by the way, it is minus half a 

percent I think, not minus 5 percent— 

Mr. GARRETT. Yes, minus .5 percent. 

Mr. BERNANKE. —increases spending and investment, increases 

the incentive for spend and invest, and that provides extra demand 

and helps the economy recover. It is certainly not a panacea, it is 

certainly not without costs and risks which I have talked about, 

and I agree with that. But I think on the whole, there is evidence 

that it has provided some support for the recovery. It is not the 

only solution, but it has had a positive effect. 

Mr. GARRETT. My time is limited. I would ask if you could come 

back to us and just indicate, have you made any mistakes in any 

of these areas, where you would have liked to seek other actions 

that you should have taken? And I will ask maybe if you could give 

us that in writing. But I will just close in the last 30 seconds on 

the situation with regard to Libor. I saw your testimony in the Senate hearing yesterday. In essence, you said you knew about it in 

2008. You said the entire world and the media knew about it in 

2008. You sort of point the finger over at London, and said you 

made some suggestions over to them what they should be doing on 

this. Isn’t there some action both the New York Fed and you could 

have taken? Aren’t there some recommendations that you could 

have made for Dodd-Frank over the last 4 years when that was 

coming forward? Isn’t there something that you could have done as 

far as regulations, perhaps with regard to how banks report their 

information to Libor, perhaps with regard to the requirements in 

43 

our banks here, perhaps setting up firewalls with regard to the offices within there that they—couldn’t you have done something? 

Mrs. BIGGERT. The gentleman’s time has expired. 

Mr. GARRETT. Can I have an answer to what he could have done? 

Mr. FRANK. The rule has been that you ask a question. We have 

people— 

Mrs. BIGGERT. The gentleman’s time has expired. The gentleman 

from North Carolina, Mr. Watt, is recognized for 5 minutes. 

Mr. WATT. Thank you, Madam Chairwoman. And let me do three 

things quickly. First of all, I want to apologize for not being here 

for your testimony, Chairman Bernanke. Unfortunately, I had a 

hearing on intellectual property in the subcommittee on which I am 

the ranking member, in the Judiciary Committee. So, I couldn’t be 

here. 

Second, I want to follow up on Congresswoman Waters’ encouragement to be more aggressive in the outreach on these real estate 

settlements. There is money there. It seems to me that there is a 

built-in disincentive for the lenders to go and find the people because they get to keep the money if they don’t find the people. So 

somebody needs to be more aggressively reaching out, even to the 

point of sending people door to door to find these folks who would 

be eligible to get the relief. So I want to encourage that. And we 

will do more encouragement offline on that. 

Third, I want to pick up on Mr. Garrett’s point and take the 

counter position. I want to express my thanks to you for shooting 

all of these bullets. Because if I hear what Mr. Garrett is saying, 

he would prefer that the Fed be as dysfunctional as Congress has 

been, and that nothing be done, and that the economy just be allowed to collapse, which I think would have been the result had not 

the Fed taken some significant actions. And I think you point that 

out on the bottom of page 5 and the top of page 6 of your abbreviated testimony when you say the important risk to our recovery 

is the domestic fiscal situation. 

As is well known, U.S. fiscal policies are on an unsustainable 

path. Development of a credible medium-term plan for controlling 

deficits should be a high priority. And you paint, unfortunately, 

kind of a doomsday scenario if Congress does not act because—and 

you lay out the significant dilemma that we are in, because we 

need to be spending short term to stimulate the economy, keeping 

tax rates low short term to stimulate the economy, yet we need to 

be more fiscally responsible. 

You can’t both spend and keep taxes low without increasing deficits. That is unsustainable. And I guess I am expressing my belief 

that Congress doesn’t seem to be up to that task. Lay out that scenario. I don’t want to get you in the politics of this, but talk to us 

a little bit more about the delicate balance short term about what 

we ought to be doing versus long term about what we ought to be 

doing. And maybe at least edify the public about how difficult these 

choices are going to be, both short and long term. 

Mr. BERNANKE. Certainly. They are very difficult choices. If Congress only allows the fiscal cliff to happen and doesn’t do anything 

else, it is actually kind of counterproductive because higher taxes 

mean that people won’t have income to spend. Less spending by the 

government means layoffs in the defense industries, for example. 

44 

So it will slow the economy and actually mean that tax revenues 

will be less than expected. And the benefits in terms of deficit reduction will be smaller than really was anticipated. And we will 

see a slower economy and less job creation. 

At the same time, if you simply push everything off without any 

additional comment, then there is the risk that people will become 

concerned that Congress has no intention ever of addressing the 

deficit. And you could see, for example, concerns in the bond market about that. 

So it is a difficult balancing act, but it is a recommendation that 

has been made not just by the Fed and the CBO, but the IMF and 

pretty much every sort of nonpartisan fiscal authority, which is to 

mitigate, moderate the extent of the fiscal cliff in the short term, 

avoid destabilizing the weak recovery, but at the same time, work 

together to establish a framework and a plan, and a credible plan 

that will, over time, over the 10-year window, and even beyond 

that, will bring our fiscal situation into balance. 

Mrs. BIGGERT. The gentleman’s time has expired. The gentleman 

from Texas, Mr. Neugebauer, is recognized for 5 minutes. 

Mr. NEUGEBAUER. Thank you, Madam Chairwoman. And Chairman Bernanke, I want to thank you. Your office was very responsive the other day when we sent you a letter in reference to the 

Libor issue. I think we will be sending you an additional letter 

today or tomorrow. One of the things that is kind of interesting to 

me, 16 banks, I think, report in the Libor dollar index, it would be 

difficult for just one bank to influence that index, wouldn’t it? 

Mr. BERNANKE. Generally, yes. 

Mr. NEUGEBAUER. So it had to be more than one bank underreporting or not accurately reporting their borrowing. Would you 

say that is correct? 

Mr. BERNANKE. The reason the banks, some of them apparently 

underreported during the crisis, was not to affect the overall Libor 

rate necessarily, but rather, because these numbers are reported 

publicly, they wanted to avoid giving the impression that they were 

weak and others were strong. 

Mr. NEUGEBAUER. But if one bank is reporting differently than 

the other ones, obviously it wouldn’t influence the overall index? 

Mr. BERNANKE. If they were in the top four or the bottom four, 

they would be cut out. 

Mr. NEUGEBAUER. That is right. So when the Fed first learned 

about this, you had some correspondence with the Bank of England, but three domestic banks were involved. Did anybody say, I 

wonder if anybody else is doing this? Or was all of your focus just 

on Barclays? 

Mr. BERNANKE. Our focus wasn’t on a specific bank. Barclays is, 

after all, a British bank, and not supervised by the Federal Reserve. Our focus was on the general phenomenon. And the New 

York Fed did two basic things: to inform the relevant regulators 

here and in the U.K. about this problem so that they could look at 

it; and to try to address the structural problems in Libor, which 

were, as you were indicating, incentivizing banks to lowball their 

rate information. So it was approached as an overall problem. 

Mr. NEUGEBAUER. Are you familiar with the term ‘‘price fixing?’’ 

Mr. BERNANKE. Of course. 

45 

Mr. NEUGEBAUER. So price fixing, if a bunch of us are in the carpet business and we all get together and we decide that we are 

going to sell carpet at this price, then that is price fixing, right? 

Mr. BERNANKE. Yes. 

Mr. NEUGEBAUER. So if money is a commodity and pricing of 

money is a function of that, wasn’t this almost price fixing on 

Libor? 

Mr. BERNANKE. It may be. But as you pointed out, there are two 

issues. One is did the individual reporting, misreporting affect the 

overall Libor? And it may or may not have. And I think that needs 

to be investigated. The other is that, in some cases, there were no 

transactions taking place. So during the crisis, there were mostly 

just overnight transactions, and yet the banks were asked to report 

what they would have to pay for money a year out. And so a question is whether or not they were, in fact, misreporting or whether 

they were simply shading their estimate in some way. So I think 

there is a question—I think the details need to come out. And we 

don’t have enough details yet to know whether this was deliberate 

price fixing or whether there was another interpretation. 

Mr. NEUGEBAUER. I think the thing that is kind of alarming to 

some of us is the fact that given how widely used that index is 

throughout our economy, from just about every area of the financial community, that I felt like the New York Fed’s response was 

a fairly lukewarm response to if, in fact, somebody was manipulating this rate, that could have huge implications. Now, it depends 

obviously whether you would have benefited from that or if you 

were penalized from that, whether you were on the buy side or the 

sell side. But can you explain why you thought—why the Fed 

thought that wasn’t a big deal? 

Mr. BERNANKE. I am sure that the Fed thought it was a big deal. 

The information was widely known. It was reported in the press. 

And the British Bankers’ Association is not subject in any way to 

U.S. policy. So it was hard to directly affect the calculation of 

Libor. But surely, it is a very big deal. It affects lots of different 

financial contracts. And as I mentioned in my comments yesterday, 

I think that one of the bad effects of all this is that it is going to 

further erode confidence in financial markets and in financial instruments. 

Mr. NEUGEBAUER. Thank you, Chairman Bernanke. 

Mr. BERNANKE. Thank you. 

Mrs. BIGGERT. The gentleman yields back. The gentleman from 

Texas, Mr. Green, is recognized for 5 minutes. 

Mr. GREEN. Thank you, Madam Chairwoman. And thank you, 

Chairman Bernanke, for being here today. I would like to yield 

most of my time to you, because I have something that I would like 

for you to respond to. I find that we have some very credible people 

who make some incredible statements. And one of the statements 

that causes a good deal of consternation is that we are now doing 

worse than we were in 2009, that the economy is in worse shape 

today than it was in 2009. 

Now, I can give my opinion on it, but I don’t think that it will 

have the impact that a person of your stature, your standing would 

have. And I am begging that you, if you would, juxtapose the auto 

industry with the auto industry today with 2009, financial services, 

46 

lending in general. Just please, if you would, so that we can bring 

some clarity to what I believe is an incredible statement. Kindly do 

so. 

Mr. BERNANKE. Nobody is satisfied with where we are today, of 

course. But there certainly has been significant improvement since 

mid-2009, when the recovery began. We have had economic growth 

now for about 3 years. The unemployment rate has fallen from 

about 10 percent to about 8 percent. Obviously, not as far as we 

would like, but still in the right direction. Banks are much stronger 

and have much more capital than they did a couple of years ago. 

Manufacturing is much stronger, has improved considerably, particularly in autos, as you mentioned. We have seen important steps 

in the energy area in terms of U.S. production and conservation. 

The housing market, which was completely dead in 2009, is still 

not where we would like it to be, but is moving in the right direction. 

So clearly, there has been improvement. I recognize that many 

Americans will still feel that the situation is not satisfactory, but 

it is going in the right direction. 

Mr. GREEN. Would you say that it is not worse than it was in 

2009, Chairman Bernanke? 

Mr. BERNANKE. Clearly not. 

Mr. GREEN. It is not currently? 

Mr. BERNANKE. Not by all the criteria I just mentioned. 

Mr. GREEN. Yes, sir. And I just want to restate a couple of 

things. We were about to lose the auto industry. We now have the 

auto industry, and it is coming back. We were about to lose a good 

portion of the financial services industry. Larger banks were about 

to go under. They are now stabilizing. AIG was about to go under. 

We lost Lehman. And it now is better than it was, obviously not 

what it was prior to the decline. And it just amazes me that credible people will make such incredible statements. And that adds 

fuel to this flame of confusion that is engulfing us. 

People want to have someone with credibility to speak truth 

about the conditions. And it is just amazing that this line of logic 

seems to have some degree of credibility in certain circles. Now, if 

you would respond, just for the record, is the auto industry in better shape now than it was in 2009? 

Mr. BERNANKE. It is producing more cars and is more profitable, 

yes. 

Mr. GREEN. Is the banking industry in better shape now than it 

was in 2009? 

Mr. BERNANKE. Yes, it is more profitable, has more capital, and 

is making more loans. 

Mr. GREEN. Is the economy in the main in better shape now than 

it was in 2009? 

Mr. BERNANKE. Again, it is not where we would like it to be, but 

many parts of the economy have improved, yes. 

Mr. GREEN. All right. Now, my next line of questions will have 

to do with something that we refer to as structural versus cyclical. 

You can’t solve structural problems if you use cyclical solutions, 

generally speaking. And it is difficult to ascertain what amount of 

what we are dealing with is structural as opposed to cyclical. Do 

you have some sense of how much of what we are trying to, for 

47 

want of a better term fix, what we are trying to fix is structural 

as opposed to cyclical? 

Mr. BERNANKE. That is widely debated, and it is hard to know 

for certain. But I guess my view, and the view of many economists, 

is that a good bit of our unemployment problem, for example, remains cyclical, which means it can be addressed in principle by 

monetary and fiscal policies. But structural problems are probably 

increasing, and in particular, the very long-term unemployed, the 

problem is, the risk is they will over time become unemployable, 

and that they will contribute therefore to a structural issue. 

Mr. GREEN. Thank you. I yield back. 

Chairman BACHUS. Mr. McHenry for 5 minutes. 

Mr. MCHENRY. Thank you, Mr. Chairman. Chairman Bernanke, 

thank you so much for being here today, and thank you for your 

service to our government and our people. I certainly appreciate 

that. Now, with quantitative easing, do you think there is a limit 

to how much quantitative easing that can be used? And do you 

think we are approaching that limit right now? 

Mr. BERNANKE. There is certainly a theoretical limit, which is 

the fact that the Federal Reserve can only buy Treasuries and 

agencies, and moreover, quantitative easing typically involves buying longer-term Treasuries and agencies, as opposed to bills, for example. So there are finite amounts of that available. And moreover, 

beyond a certain point, if the Federal Reserve owned too much, it 

would greatly hurt market functioning, which would have the effect 

of reducing the efficacy of the policy. So I wouldn’t say that we are 

at that point yet, but ultimately, there would be some limit to how 

much you could do, yes. 

Mr. MCHENRY. So there is some limit? 

Mr. BERNANKE. Yes. 

Mr. MCHENRY. But we are nowhere close to approaching it is 

what you are saying? 

Mr. BERNANKE. I don’t have a number for you. But we still have 

some capacity at this point, yes. 

Mr. MCHENRY. Okay. Now, there is a separate question. You said 

that you have a target inflation number, sort of ideal. And what 

is that? 

Mr. BERNANKE. Two percent. 

Mr. MCHENRY. Okay. Now, would the Fed be comfortable with 

an inflation rate a little higher than that? Maybe 3 percent? 

Mr. BERNANKE. I don’t know what you mean by ‘‘comfortable.’’ If 

for whatever reason, for example, in the last few years, we have 

seen oil price shocks which have driven inflation up to 3 percent 

or higher, that is not a good situation. And it is our objective in 

that case to try to move inflation gradually down back to 2 percent. 

So if you are asking would we target 3 percent, would we seek to 

get 3 percent, the answer is no. 

Mr. MCHENRY. Are you more comfortable with 3 percent or 1 

percent? A little higher or a little lower? What are you more comfortable— 

Mr. BERNANKE. I think both of those are concerns. Both are concerns because 3 percent, of course, means that we are moving towards a more inflationary situation, but 1 percent is closer to the 

deflation range, which is also not healthy for the economy. 

48 

Mr. MCHENRY. Okay. The reason why I am trying to get at this 

is because there has been a lot of discussion that with a little higher inflation rate, a belief—now, I don’t subscribe to this—but a little higher inflation rate that it, de facto, reduces debt burdens and 

perhaps could spur spending and the perception, more of the perception of less debt and actually the impact of it. And that might 

spur the economy. It is more consumer spending. Do you think that 

is desirable or not desirable? 

Mr. BERNANKE. I recognize that some people would advocate that 

we set an inflation target, say at 4 percent, and maintain that for 

a number of years. I don’t think, first, that we could do that without losing control of the inflation process. Second, I am very skeptical that it would increase confidence among businesses and 

households and increase economic activity. I think it would create 

a lot of problems in financial markets as well. So I don’t think that 

is a strategy that has a lot of support on the Federal Open Market 

Committee. 

Mr. MCHENRY. So a lower inflation rate, the target inflation rate 

of around 2 percent, the Fed would have more control than perhaps 

a higher inflation rate? 

Mr. BERNANKE. Because we have maintained inflation near 2 

percent for a long time, and there is a lot of confidence in the financial markets that the Fed will keep inflation close to 2 percent. 

Mr. MCHENRY. Okay. So it is confidence, but also Fed capacity? 

Mr. BERNANKE. The issue is that we currently have very well-anchored inflation expectations. People are strongly accustomed to 2 

percent inflation. If we were to say 4 percent, first would be the 

issue of getting there. Could we get there? And could we get there 

with some accuracy? But beyond that, people would say, if they 

said 4 percent, why not 6 percent, why not 8 percent? So in the 

short run at least, it is not at all clear that people would be confident that this new target of 4 percent would, in fact, be stable 

and sustainable. Instead, they would wonder where inflation is 

going to be in the medium term. 

Mr. MCHENRY. So right now, in order to—with the Fed contemplating more easing, and then you also have the question of liquidity in the marketplace, making sure that Fed policy enables more 

liquidity in the marketplace, we also see Europe running counter 

to that, right? The woes of Europe are making the markets less liquid. Does the Volcker Rule—do you have a concern about the timing of the Volcker Rule that would rein in liquidity? 

Mr. BERNANKE. We are paying close attention to issues related 

to market liquidity and market making, which are exempt activities under the Volcker Rule. In any case, the Volcker Rule doesn’t 

come into effect for a couple more years. So I would say that is not 

a first order issue right now. 

Mr. MCHENRY. Thank you. 

Chairman BACHUS. I am now going to recognize Mr. Perlmutter. 

And let me say this, we have a hard stop at 12:45. So if you want 

all the time, you can have it. Mr. Pearce would like a minute, if 

you can work that out. 

Mr. PERLMUTTER. I will be quick. Chairman Bernanke, thank 

you for being here, thank you for maintaining a steady hand 

through all of this, whether it was kind of the collapse on Wall 

49 

Street or some of the clashes that we have here in Congress ideologically that don’t give the economy some of the fiscal tools that 

I think would also help continue to improve our economic situation. 

And so I want to ask a couple of specific questions and then see 

where we are. Can we talk a little bit about Basel III for a second, 

because it came up in a conversation yesterday with a mediumsized bank that we have back in Colorado. In Dodd-Frank, we established some lower limits as to a lot of the regulations that go 

in place. And I think either it was a $10 or $15 billion-sized institution, and if you were above it, you had many more things that 

you had to do, whether it is dealing with derivatives or the like. 

And as I understand it now, these Basel III regulations, that could 

potentially become worldwide-type regulations, are going down to 

a half a billion dollars, $500 million. And it would take into consideration lots of smaller banks. And they are fearful that this will 

really dry up their capital and make it very difficult for them to 

continue to operate. Can you comment on that? 

Mr. BERNANKE. Yes. Certain parts of Basel III are being proposed to go down to smaller banks, some of the risk weights, for 

example, some of the basic capital definitions. And the idea here 

is to try to make sure that small banks as well as large banks are 

well-capitalized. But I think it is important to note two things. 

First, many of the aspects of Basel III do not apply to small banks. 

They simply are—first of all, things like derivatives books and 

things of that sort just aren’t relevant to small banks. And there 

are other rules such as the international leverage ratio which applies only to the largest internationally active banks. 

Mr. PERLMUTTER. But I want to impress on you, if I could, I 

would like you to take this away, say you are a smaller Colorado 

bank, you are generally going to have loans on shoppettes and real 

estate and some home loans and some small business loans. And 

in my opinion, it wasn’t the smaller banks that led us into the deep 

recession that we suffered in 2008 and 2009. And I would just ask 

you, as Chairman of our central bank, to make sure that we don’t 

penalize—we were pretty tough in some of the Dodd-Frank regulations that we passed to make sure that the banking system had 

some restraints, didn’t just run amok, that there was capital, and 

there were certain things that had to be watched closely. But I 

would ask you, sir, to just keep an eye on that, if you would. My 

last question, and then I will turn it over to Mr. Pearce, is can you 

describe for us what has happened with the liquidation of the assets that were in Maiden Lane one, two, and three? 

Mr. BERNANKE. They basically have been sold off, and the Federal Reserve and the government and the taxpayer received all 

their money back with interest and additional profits beyond that. 

So it has all been sold back into the marketplace. 

Mr. PERLMUTTER. So we pretty much liquidated it all or do we 

hold any of it? 

Mr. BERNANKE. We have a little bit left, but we have paid off the 

loans. So we are, from now on, whatever we sell is pure profit. 

Mr. PERLMUTTER. All right. Thank you. Mr. Chairman, I will 

yield back. 

Chairman BACHUS. Thank you. And Mr. Pearce for 1 minute. 

50 

Mr. PEARCE. I thank the gentleman for his consideration. Mr. 

Chairman, thank you for your service. I am looking at page 4, 

where you talk about the great risks to us financially. And I assume that is because of their size and because of the underfunding 

of them. But when I look at that size, I consider the pension systems. And just yesterday, the California pension system said that 

they only got a 1 percent rate of return. Their projection, in order 

to be solvent, is up in the 73⁄4. Maybe just in that one system, the $500 billion shortfall now just on the teachers. And then that is the 

smaller of the two. Nationwide, maybe a $3 trillion shortfall. I 

didn’t see that, but I do see Spain talked about, and yet Spain is 

only $1 trillion exposure. Could you kind of tell us what the risk 

is associated with the unfunded pensions? 

Mr. BERNANKE. Low interest rates do put some stress on pension 

funds and life insurance companies for the reasons that you described. I think our goal, basically, is to get the economy strong 

enough that returns will rise and that things will normalize over 

time. Obviously, pension funds can’t be underfunded forever. But 

if the economy strengthens and returns go back to a more normal 

level, then these underfunding problems will not disappear, of 

course, but they will be mitigated. 

Mr. PEARCE. Thank you, Mr. Chairman. I yield back. 

Chairman BACHUS. Thank you. Chairman Bernanke, the committee appreciates your testimony today. And you are dismissed. 

I am going to ask the audience to remain in your seats until 

Chairman Bernanke and his staff exit. 

Mr. Schweikert is recognized for a unanimous consent request. 

Mr. SCHWEIKERT. Mr. Chairman, I request unanimous consent to 

place a letter into the record. It is just some concerns and wanting 

some additional visibility on the PCCRAs, the premium capture reserve accounts, and where we are going on that policywise. 

Chairman BACHUS. Without objection, it is so ordered. 

The Chair notes that some Members may have additional questions for Chairman Bernanke, which they may wish to submit in 

writing. Without objection, the hearing record will remain open for 

30 days for Members to submit written questions to Chairman 

Bernanke and to place his responses in the record. 

This hearing is adjourned. 

[Whereupon, at 12:49 p.m., the hearing was adjourned.] 

(51) 

A P P E N D I X 

July 18, 2012 

52 


76116.001

United States House of Representatives 

Committee on Financial Services 

Hearing on Monetary Policy and the State of the Economy 

July 18,2012 

Congressman Ron Paul 

Statement for the Record 

Mr. Chairman, I thank you for calling this hearing today on monetary policy and the state of the 

economy. For the past few years the Federal Reserve has received criticism from all sides of the 

political spectrum, and rightly so, for its unprecedented intervention into the economy and its bailouts 

oflarge Wall Street banks and foreign central banks. Yet this criticism risks losing sight of the most 

insidious result of the Fed's actions, which is to enable the growth of government. 

For nearly the first 40 years of its existence, the Fed operated as an adjunct of the Treasury 

Department, tasked with purchasing government debt in order to keep the government's borrowing 

costs low. Even after gaining its vaunted "independence" from Treasury in 1951, the Fed never shrank 

from enabling the growth of government. The extraordinary monetary policy of the last four years has 

reaffirmed that the Fed, its protestations to the contrary notwithstanding, is only too willing to enable 

growing government spending and massive fiscal deficits. 

For centuries, banks have received special privileges from government in exchange for funding 

the government's wars. The creation of the Federal Reserve System in 1913 formalized and centralized 

this arrangement in the United States. From the very beginning, the Fed was intended to provide a 

more liquid market for federal government debt, enabling the growth of big government. 

What we've seen over the last century is nothing less than the remaking of American 

government, thanks in large part to the Fed. Its loose monetary policy gave rise to: (i) the welfare 

state, encouraging dependency on government largesse and destroying the work ethic and family life of 

lower-income Americans; (ii) the warfare state, allowing the U.S. government to involve itself in wars 

of aggression around the world; and (iii) the regulatory state, the mammoth bureaucracy that 

relentlessly grinds away at the rights of the American people. 

Little more than a decade ago, Fed economists were wringing their hands over the prospect that 

the federal government might pay off the national debt. Nothing could be worse for the Fed, because 

the Fed's monetary policy operations require the existence of government debt. Treasury debt is 

purchased from or sold to banks on the open market in order to influence interest rates. Without 

government debt, the Fed would have no idea how to conduct monetary policy. From a free market 

perspective this would be wonderful, as it is Fed monetary policy which largely creates the booms and 

busts of the business cycle. Unfortunately, the federal government has run up the national debt to 

unprecedented levels over the past decade, and the Federal Reserve has been right there, monetizing 

that debt to ensure that none of it goes unsold. 

While the desire of foreign countries and private investors to purchase Treasuries was drying 

up, the Federal Reserve was only too willing to step in and enable the government to continue its 

deficit spending. The Fed's balance sheet exploded as it purchased over one trillion dollars in Treasury 

debt over the past few years. And before it did that, the Fed also purchased over a trillion dollars of 

overrated mortgage-b\lcked securities from Wall Street banks, giving those banks the cash they needed 

to purchase Treasury debt of their own. Were it not for the Federal Reserve's actions, the federal 

government would not have been able to run trillion-dollar deficits for the past several years. 

In fact, had the Federal Reserve never been created, the federal government never would have 

been able to run up a $16 trillion debt. No market actor would lend money to such a major debtor at 

such low interest rates. The only reason that banks are willing to buy Treasury debt at such low interest 
53 


76116.002

rates is because they can easily resell that debt to the Fed. 

Without the Fed, interest rates would rise to such levels that the federal government would have 

no choice but to curtail its expenditures and focus only on doing what is truly necessary. With market 

discipline allowed to prevail, the size of the federal government would be drastically smaller. If 

Congress were really serious about limiting the size of government, it would eliminate the most 

important enabler of government profligacy by ending the Fed. 
54 


76116.003

For release on delivery 

10:00 a.m. EDT 

July 18,2012 

Statement by 

Ben S. Bernanke 

Chairman 

Board of Governors of the Federal Reserve System 

before the 

Committee on Financial SerVices 

U.S. House of Representatives 

July 18,2012 
55 


76116.004

Chrunnan Bachus, Ranking Member Frank, and other members of the Committee, I am 

pleased to present the Federal Reserve's semiannual Monetary Policy Report to the Congress. 

will begin with a discussion of current economic conditions and the outlook before turning to 

monetary policy. 

The Economic Outlook 

The U.S. economy has continued to recover, but economic activity appears to have 

decelerated somewhat during the fIrst half of this year. After rising at an annual rate of 

2-112 percent in the second halfof2011, real gross domestic product (GDP) increased at a 

2 percent pace in the fIrst quarter of2012, and available indicators point to a still-smaller gain in 

the second quarter. 

Conditions in the labor market improved during the latter part of 20 11 and early this year, 

with the unemployment rate falling about a percentage point over that period. However, after 

running at nearly 200,000 per month during the fourth and first quarters, the average increase in 

payroll employment shrank to 75,000 per month during the second quarter.· Issues related to 

seasonal adjustment and the unusually warm weather this past winter can account for a part, but 

only a part, of this loss of momentum in job creation. At the same time, the jobless rate has 

recently leveled out at just over 8 percent. 

Household spending has continued to advance, but recent data indicate a somewhat 

slower rate of growth in the second quarter. Although declines in energy prices are now 

providing some support to consumers' purchasing power, households remain concerned about 

their employment and income prospects and their overall level of confidence remains relatively 

low. 
56 


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-2-

We have seen modest signs of improvement in housing. In part because of historically 

low mortgage rates, both new and existing home sales have been gradually trending upward 

since last summer, and some measures of house prices have turned up in recent months. 

Construction has increased, especially in the multifamily sector. Still, a number of factors 

continue to impede progress in the housing market. On the demand side, many would-be buyers 

are deterred by worries about their own [mances or about the economy more generally. Other 

prospective homebuyers cannot obtain mortgages due to tight lending standards, impaired 

creditworthiness, or because their current mortgages are underwater--that is, they owe more than 

their homes are worth. On the supply side, the large number of vacant homes, boosted by the 

ongoing inflow of foreclosed properties, continues to divert demand from new construction. 

After posting strong gains over the second half of 2011 and into the first quarter of2012, 

manufacturing production has slowed in recent months. Similarly, the rise in real business 

spending on equipment and software appears to have decelerated from the double-digit pace seen 

over the second half of2011 to a more moderate rate of growth over the first part of this year. 

Forward-looking indicators ofinvestrnent demand--such as surveys of business conditions and 

capital spending plans--suggest further weakness ahead. In part, slowing growth in production 

and capital investment appears to reflect economic stresses in Europe, which, together with some 

cooling in the economies of other trading partners, is restraining the demand for U.S. exports. 

At the time of the June meeting of the Federal Open Market Committee (FOMC), my 

colleagues and I projected that, under the assumption of appropriate monetary policy, economic 

growth will likely continue at a moderate pace over coming quarters and then pick up very 

gradually. Specifically, our projections for growth in real GDP prepared for the meeting had a 
57 


76116.006

- 3 -

central tendency of 1.9 to 2.4 percent for this year and 2.2 to 2.8 percent for 2013. l These 

forecasts are lower than those we made in January, reflecting the generally disappointing tone of 

the recent incoming data.2 In addition, financial strains associated with the crisis in Europe have 

increased since earlier in the year, which--as I already noted--are weighing on both global and 

domestic economic activity. The recovery in the United States continues to be held back by a 

number of other headwinds, including still-tight borrowing conditions for some businesses and 

households, and--as I will discuss in more detail shortly--the restraining effects of fiscal policy 

and fiscal uncertainty. Moreover, although the housing market bas shown improvement, the 

contribution of this sector to the recovery is less than has been typical of previous recoveries. 

These headwinds should fade over time, allowing the economy to grow somewhat more rapidly 

and the unemployment rate to decline toward a more normal level. However, given that growth 

is projected to be not much above the rate needed to absorb new entrants to the labor force, the 

reduction in the unemployment rate seems likely to be frustratingly slow. Indeed, the central 

tendency of participants' forecasts now bas the unemployment rate at 7 percent or higher at the 

end·of2014. 

The Committee made comparatively small changes in June to its projections for inflation. 

Over the first three months of 20 12, the price index for personal consumption expenditures 

(PCE) rose about 3-1/2 percent at an annual rate, boosted by a large increase in retail energy 

prices that in turn reflected the higher cost of crude oil. However, the sharp drop in crude oil 

I See table 1, "Economic Projections of Federal Reserve Board Members and Federal Reserve Bank Presidents, June 

2012," of the Summary of Economic Projections, available at the Board of Governors of the Federal Reserve System 

(2012), "Federal Reserve Board and Federal Open Market Committee Release Economic Projections from the June 

19-20 FOMC Meeting," press release, June 20, 

www.federalreserve.gov/newsevents/press/monetaryI20120620b.htm; table 1 is also available in Part 4 of the July 

Monetary Policy Report to the Congress. 

2 Ben S. Bernanke (2012), "Semiannual Monetary Policy Report to the Congress," statement before the Committee 

on Financial Services, U.S. House of Representatives, February 29, 

www.federalreserve.gov/newsevents/teslimonyibernanke20120229a.htm. 
58 


76116.007

-4-

prices in the past few months has brought inflation down. In all, the PCE price index rose at an 

annual rate of 1-112 percent over the first five months of this year, compared with a 2-1/2 percent 

rise over 2011 as a whole. The central tendency of the Committee's projections is that inflation 

will be 1.2 to 1.7 percent this year, and at or below the 2 percent level that the Committee judges 

to be consistent with its statutory mandate in 2013 and 2014. 

Risks to the Outlook 

Participants at the June FOMe meeting indicated that they see a higher degree of 

uncertainty about their forecasts than normal and that the risks to economic growth have 

increased. I would like to highlight two main sources of risk: The first is the euro-area fiscal 

and banking crisis; the second is the U.S. fiscal situation. 

Earlier this year, financial strains in the euro area moderated in response to a number of 

constructive steps by the European authorities, including the provision of three-year bank 

financing by the European Central Bank. However, tensions in euro-area fmancial markets 

intensified again more recently, reflecting political uncertainties in Greece and news oflosses at 

Spanish banks, which in turn raised questions about Spain's fiscal position and the resilience of 

the euro-area banking system more broadly. Euro-area authorities have responded by 

announcing a number of measures, including funding for the recapitalization of Spain's troubled 

banks, greater flexibility in the use of the European financial backstops (including, potentially, 

the flexibility to recapitalize banks directly rather than through loans to sovereigns), and 

movement toward unified supervision of euro-area banks. Even with these announcements, 

however, Europe's fmancial markets and economy remain under significant stress, with spillover 

effects on finaneial and economic conditions in the rest of the world, including the United States. 
59 


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- 5 -

Moreover, the possibility that the situation in Europe will worsen further remains a significant 

risk to the outlook. 

The Federal Reserve remains in close communication with our European counterparts. 

Although the politics are complex, we believe that the European authorities have both strong 

incentives and sufficient resources to resolve the crisis. At the same time, we have been focusing 

on improving the resilience of our financial system to severe shocks, including those that might 

emanate from Europe. The capital and liquidity positions of U.S. banking institutions have 

improved substantially in recent years, and we have been working with U.S. financial firms to 

ensure they are taking steps to manage the risks associated with their exposures to Europe. That 

said, European developments that resulted in a significant disruption in global financial markets 

would inevitably pose significant challenges for our [mancial system and our economy. 

The second important risk to our recovery, as I mentioned, is the domestic fiscal 

situation. As is well known, U.S. fiscal policies are on an unsustainable path, and the 

development of a credible medium-term plan for controlling deficits should be a: high priority. 

At the same time, fiscal decisions should take into account the fragility of the recovery. That 

recovery could be endangered by the confluence of tax increases and spending reductions that 

will take effect early next year if no legislative action is taken. The Congressional Budget Office 

has estimated that, if the full range of tax increases and spending cuts were allowed to take 

effect--a scenario widely referred to as the fiscal cIiff--a shallow recession would occur early 

next year and about 1-114 million fewer jobs would be created in 2013.3 These estimates do not 

3 Congressional Budget Office (2012), Economic Effects a/RedUCing the Fiscal Restraint That Is Scheduled to 

Occur in 2013 (Washington: CBO, May), availahle at www.cbo.govfpublicationl43262. The effect of the fiscal 

cliff on real GDP is shown in table 2 (po 6). The effect of the fiscal cliff on employment, relative to a less restrictive 

alternative fiscal scenario that assumes that most expiring tax provisions are extended and that the spending 

sequestration does not take effect, is shown in table 3 (p.7), 
60 


76116.009

- 6-

incorporate the additional negative effects likely to result from public uncertainty about how 

these matters will be resolved. As you recall, market volatility spiked and confidence fell last 

summer, in part as a result of the protracted debate about the necessary increase in the debt 

ceiling. Similar effects could ensue as the debt ceiling and other difficult fiscal issues come into 

clearer view toward the end of this year. 

The most effective way that the Congress could help to support the economy right now 

would be to work to address the nation's fiscal challenges in a way that takes into account both 

the need for long-run sustainability and the fragiJity of the recovery. Doing so earlier rather than 

later would help reduce uncertainty and boost household and business confidence. 

Monetary Policy 

In view of the weaker economic outlook, subdued projected path for inflation, and 

significant downside risks to economic growth, the FOMC decided to ease monetary policy at its 

June meeting by continuing its maturity extension program (or MEP) through the end of this 

year. The MEP combines sales of short-term Treasury securities with an equivalent amount of 

purchases oflonger-term Treasury securities. As a result, it decreases the supply oflonger-term 

Treasury securities available to the public, putting upward pressure on the prices of those 

securities and downward pressure on their yields, without affecting the overall size of the Federal 

Reserve's balance sheet By removing additional longer-term Treasury securities from the 

market, the Fed's asset purchases also induce private investors to acquire other longer-term 

assl'lts, such as corporate bonds and mortgage backed-securities, helping to raise their prices and 

lower their yields and thereby making broader financial conditions more accommodative. 

Economic growth is also being supported by the exceptionally low level of the target 

range for the federal funds rate of 0 to 1/4 percent and the Committee's forward guidance 
61 


76116.010

- 7 -

regarding the anticipated path of the funds rate. As I reported in my February testimony, the 

FOMC extended its forward guidance at its January meeting, noting that it expects that economic 

conditions--including low rates of resource utilization and a subdued outlook for inflation over 

the medium run--are likely to warrant exceptionally low levels for the federal funds rate at least 

through late 2014. The Committee has maintained this conditional forward guidance at its 

subsequent meetings. Reflecting its concerns about the slow pace of progress in reducing 

unemployment and the downside risks to the economic outlook, the Committee made clear at its 

June meeting that it is prepared to take further action as appropriate to promote a stronger 

economic recovery and sustained improvement in labor market conditions in a context of price 

stability. 

Thank you. I would be pleased to take your questions. 
62 


76116.071

(ftOltgr.ess of tlJ.e lQuit.el't §iuics 

liIlfasi1ingfnn, il<!t 20515 

Chairman Spencer Bachus 

House Financial Services Committee 

2129 Rayburn House Office Building 

Washington, DC 20515 

Dear Chairman Bachus: 

July 18,2012 

I submit the enclosed letter and respectfully request its inclusion in the record for the July 18, 

2012 Financial Services Committee hearing entitled, "Monetary Policy and the State ofthe 

Economy." 

An area of the Dodd-Frank Act that has been subject to major rulemakmg by regulatory agencies 

has been section 941, Risk Retention. Included in the risk retention proposed rule is the Premium 

Capture Cash Reserve Account (PCCRA), which places securitization profits in a first-loss 

position of a securitization. As proposed, the PCCRA would eliminate the financial incentive for 

issuing structured securities, including both private-label residential and all commercial 

mortgage-backed securities. 

The PCCRA was not part of the Dodd-Frank Act or even contemplated by Congress and was 

created entirely by the regulators. In separate letters, both House and Senate members have 

strongly expressed to regulators that the PCCRA was not part of Congressional intent for the 

Dodd-Frank Act and have urged them to remove it from the final rule. 

The enclosed is the Senate letter that speaks to this issue, dated June 19,2012, signed by a 

bipartisan coalition of twelve Senators. I submit the enclosed for inclusion in the record for 

today's hearing, "Monetary Policy and the State of the Economy." 

PRINTED ON R!::CYCLED PAPER 
63 


76116.072

WASH!NGTON. D.C. 20510 

June 19. 2012 

The Honorable Shaun Donovan 

Secretary 

Department of HUD 

451 7th Street. SW 

Washington. DC 20551 

The Honorable Mary Schapiro 

Chairman 

Securities and Exchange Commission 

100 F Street, NE 

Washington, DC 20549 

The Honorable Tom Curry 

Comptroller 

Office of the Comptroller of the Currency 

250 E Street, SW 

Washington, DC 20219 

The Honorable Ben Bernanke 

Chairman 

The Federal Reserve System 

20th Street and Constitution Ave. NW 

Washington. DC 20429 

The Honorable Marty Gruenberg 

Acting Chairman 

Federal Deposit Insurance Corporation 

550 17th Street NW 

Washington. DC 20429 

Mr. Edward DeMarco 

Acting Director 

Federal Housing Finance Agency 

400 7th Street, SW 

Washington, DC 20024 

Dear Secretary Donovan, Chairmen Bemanke, Schapiro, Acting Chairman Gruenberg. 

Comptroller Curry, and Acting Director DeMarco: 

We are writing to you with concerns regarding the risk retention proposal issued by your 

agencies pursuant to Section 941 of the Dodd-Frank Wall Street Reform and Consumer 

Protection Act (P.L. 111-203). Rather than promoting the flow of credit in the 

commercial real estate and residential mortgage sector, the proposed rule goes in the 

wrong direction and takes away the flexibility Congress intended by applying a rigid 

approach and adding extraneous features, such as the Premium Capture Cash Reserve 

Account and an excessively rigid down-payment requirement in the Qualified 

Residential Mortgage exclusion. 

On March 31, 2011, the joint risk retention rule proposal was released for comment. 

Since then, the six federal financial services regulators have received 13,000 letters in 

response to the proposal. 

Congress specifically rejected a one-size fits an risk retention rule for well-underwritten 

qualified residential mortgages ("QRM") and commercial-mortgage backed securities 

("CMBS"). Section 941 recognized that QRM and CMBS, were unique, treated them 

uniquely under the law, and required that they be distinguished under the proposed 

rules. The merits of this approach was reinforced by the Federal Reserve's October 

2010 study, which recommended "crafting credit risk retention requirements that are 

tailored to each major class of securitized assets" and "to ensure that the regulations 

promote the purposes of the Act without unnecessarily reducing the supply of credit." 
64 


76116.073

In the area of CMBS and residential mortgage-backed securities ("RMBS") we are 

ccncerned that regulators included a requirement for the establishment of Premium 

Capture Cash Reserve Accounts ("PCCRAsU

) in the proposed rule that would negatively 

impact capital formation. The PCCRA, which was not envisioned by Congress, would 

require securitizers to set aside the premium from the sale of securities in separate 

acccunt for the life of the security. This account would occupy the first loss position and 

would be in addition to the 5% risk retention requirement. The end result would be that 

securitizers could not recognize compensation until the security matures many years 

later and would be forced to bear all downside risk associated with interest rate 

exposure while waiting years to recognize any potential profit from that risk. The 

alternatives to creating the PCCRA are not appealing to those investors the rules are 

deSigned to protect and would require a significant restructuring of CMBS and RMBS 

deals. 

This approach fundamentally alters the existing securitization model, conflicting with the 

Financial Stability OverSight Council's own report on the objectives for risk retention 

which noted in objective one to, "align incentives without changing the basic structure 

and objectives of securitization transactions. n We believe that the PCCRA goes well 

beyond Congressional intent and we urge you to reconsider its inclusion in the risk 

retention proposal. 

We have also expressed ccncerns about the rigid QRM definition in the past. The QRM 

exclusion to risk retention is key to attracting private capital to the mortgage 

securitization market and restoring confidence to ccnsumers, lenders and investors. 

The down-payment restriction of the proposed regulation goes beyond the intent and 

language of the statute and would increase ccnsumer costs and reduce access to 

affordable credit. 

Despite Congressional direction on these issues, the proposed rule uses a 

homogenized approach that takes away the asset-specific flexibility provided by 

Congress. We are concerned this will cut off or greatly reduce a vital source of capital 

across all asset classes. Congress crafted a statute that was designed to provide the 

appropriate balance between strong standards that align the interests of lenders, 

issuers and investors with the ability of the securitization process to work. The 

proposed rule does not accomplish this goal. We urge you to modify the proposed risk 

retention rule to follow Congressional intent by eliminating the PCCRA and the 

unnecessarily tight down payment restrictions on QRM. 

Sincerely, 
65 


76116.074

~ - ~~~ 

~'i Momo t ~ , 7 

~~._ ~KJ1 

_~~ ~~tL:J-

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66 


76116.011
67 


76116.012
68 


76116.013

Letter of Transmittal 

BOARD OF GOVERNORS OF THE 

FEDERAL RESERVE SYSTEM 

Washington, D.C., July 17, 2012 

THE PRESIDENT OF THE SENATE 

THE SPEAKER OF THE HOUSE OF REPRESENTATIVES 

The Board of Governors is pleased to submit its Monetary Policy Report to the Congress 

pursuant to section 2B of the Federal Reserve Act. 
69 


76116.014

Contents 

Part 1 

Overview: Monetary Policy and the Economic Outlook .............................................. 1 

Part 2 

Recent Economic and Financial Developments ................................................................ 5 

DOMESTIC DEVELOPMENTS .......................................................................................•......... 6 

The Household Sector ....................................................................................................... 6 

Consumer Spending and Household Finance .............................................................. 6 

Housing Activity and Housing Finance ....................................................................... 8 

The Business Sector ......................................................................................................... 1 0 

Fixed Investment ........................................................................................................ 10 

Inventory Investment .................................................................................................. 11 

Corporate Profits and Business Finance .................................................................... 12 

The Government Sector .................................................................................................. 14 

Federal Government ................................................................................................... 14 

State and Local Government ...................................................................................... 16 

The External Sector ......................................................................................................... 16 

Exports and Imports ................................................................................................... 16 

Commodity and Trade Prices .................................................................................... 17 

The Current and Financial Accounts ......................................................................... 17 

National Saving ................................................................................................................ 18 

The Labor Market ........................................................................................................... 19 

Employment and Unemployment ............................................................................... 19 

Productivity and Labor Compensation ...................................................................... 20 

Prices ............................................................................................................................... .21 

FINANCIAL DEVELOPMENTS ........•..................................................................................... 22 

Monetary Policy Expectations and Treasury Rates ...................................................... 22 

Short-Term Funding Markets ........................................................................................ 23 

Financial Institutions ...................................................................................................... 25 

Corporate Debt and Equity Markets ............................................................................. 27 

Monetary Aggregates and the Federal Reserve's Balance Sheet .................................. 29 

INTERNATIONAL DEVELOPMENTS .•..................•................................................................ 32 

International Financial Markets ..................................................................................... 32 

Advanced Foreign Economies ........................................................................................ 35 

Emerging Market Economies ......................................................................................... 37 
70 


76116.015

ii 

Part 3 

Monetary Policy: Recent Developments and Outlook ................................................ 39 

Monetary Policy over the First Half of 2012 ................................................................ 39 

FOMC Communications ............................................................................................... .41 

Part 4 

Summary of Economic Projections ................................................................................... 43 

The Outlook for Economic Activity ............................................................................. .46 

The Outlook for Inflation .............................................................................................. .46 

Appropriate Monetary Policy ........................................................................................ .49 

Uncertainty and Risks .................................................................................................... 53 

Abbreviations .......................................................................................................................... 57 

List of Boxes 

The Supply of Mortgage Credit ..................................................................................... 10 

The Capital and Liquidity Position of Large U.S. Banks ............................................ 24 

Implementing the New Financial Regulatory Regime .................................................. 28 

An Update on the European Fiscal and Banking Crisis .............................................. 34 

Forecast Uncertainty ....................................................................................................... 55 
71 


76116.016

Part 1 

Overview: 

Monetary Policy and the Economic Outlook 

The pace of economic recovery appears to have slowed 

during the first half of this year, with real gross domestic product (GDP) likely having risen at only a modest 

pace. In the labor market, the rate of job gains has 

diminished recently, and, following a period of 

improvement, the unemployment rate has been little 

changed at an elevated level since January. Meanwhile, 

consumer price inflation over the first five months of 

2012 was lower, on net, than in 2011, and longer-term 

inflation expectations have remained stable. A number 

of factors will likely restrain economic growth in the 

period ahead, including weak economic growth abroad 

and a fiscal environment that looks set to become less 

accommodative. Uncertainty about these factors may 

also restrain household and business spending. In 

additioll, credit conditions are likely to improve only 

gradually, as are still-elevated inventories of vacant and 

foreclosed homes. Moreover, the possibility of a further material deterioration of conditions in Europe, or 

of a particularly severe change in U.S. fiscal conditions, 

poses significant downside risks to the outlook. 

Against this backdrop, the Federal Open Market 

Committee (FOMC) took steps to provide additional 

monetary policy accommodation during the first half 

of 2012. In particular, the Committee changed its forward guidance regarding the period over which it 

anticipates the federal funds rate to remain at exceptionally low levels and announced a continuation of its 

maturity extension program (MEP) through the end of 

the year. These policies put downward pressure on 

longer-term interest rates and made broad financial 

conditions more accommodative than they would otherwise be, thereby supporting the economic recovery. 

The European fiscal and banking crisis has remained 

a major source of strain on global financial markets. 

Early in the year, financial stresses within the euro area 

moderated somewhat in light of a number of policy 

actions: The European Central Bank (ECB) provided 

ample liquidity to the region's banks, euro-area leaders 

agreed to increase the lending capacity of their rescue 

facilities, and a new assistance package for Greece was 

approved following a restructuring of Greek sovereign 

debt. However, tensions within the euro area increased 

again in the spring as political uncertainties rekindled 

fears of a disorderly Greek exit from the euro area and 

mounting losses at Spanish banks renewed questions 

abont the sustainability of Spain's sovereign debt and 

the resiliency of the euro-area banking system. As 

yields on the government debt of Spain and other vulnerable European countries rose toward new highs, 

euro-area leaders responded with additional policy 

measures in late June, including increasing the tlexibility of the region's financial backstops and making 

progress toward greater cooperation in the supervision 

and, as necessary, recapitalization of Europe's banks. 

Many critical details, however, remain to be worked 

out against a backdrop of continued economic weakness and political strain. 

Financial markets were somewhat volatile over the 

first half of 2012 mostly due to fluctuating views 

regarding the crisis in the euro area and the likely pace 

of economic growth at home and abroad. As investors' 

concerns about the situation in Europe eased early in 

the year and with data releases generally coming in to 

the upside of market expectations, broad equity price 

indexes rose and risk spreads in several markets narrowed. Subsequently, however, market participants 

pulled back from riskier assets amid renewed concerns 

about the euro area and evidence of slowing global 

economic growth. Retlecting these developments bnt 

also owing to the lengthening of the forward rate guidance, continuation of the MEP, and increased expectations by market participants of additional balance 

sheet actions by the Federal Reserve, yields on longerterm Treasury securities and corporate debt as well as 

rates on residential mortgages declined, on net, and 

reached historically low levels at times during the first 

half of the year. On balance since the beginning of the 

year, broad equity prices rose as corporate earnings 

remained fairly resilient through the first quarter. 

After rising at an annual rate of 2\1, pereent in the 

second half of 201l, real GDP increased at a 2 percent 

pace in the first quarter of 2012, and available indicators point to a still smaller gain in the second quarter. 

Private spending continues to be weighed down by a 

range of factors, including uncertainty about developments in Europe and the path for U.S. fiscal policy, 

concerns about the strength and sustainability of the 

recovery, the still-anemic state of the housing market, 

and the difficulties that many would-be borrowers con-
72 


76116.017

2 Monetary Policy Report to the Congress 0 July 2012 

tinue to have in obtaining credit. Such considerations 

have made some businesses more cautious about 

increasing investment or materially expanding their 

payrolls and have led households to remain quite pessimistic about their income and employment prospects. 

Smoothing through the effects of nnseasonably warm 

weather this past winter, activity in the housing sector 

appears to have been a little stronger so far this year. 

However, the level of housing activity remains low and 

continues to be held down by tight mortgage credit. 

Meanwhile, the drag on real GDP growth from government purchases is likely to persist, as budgets for state 

and local governments remain strained and federal 

fiscal policy is likely to become more restrictive in 

2013. 

In the labor market, gains in private payroll employment averaged 225,000 jobs per month in the first 

quarter, up from 165,000 jobs per month in the second 

half of last year, but fell back in the second quarter to 

just 90,000 jobs per month. Although the slowing in 

the pace of net job creation may have been exaggerated 

by issues related to swings in the weather and to seasonal adjustment difficulties associated with the timing 

of the sharpest job losses during the recession, those 

factors do not appear to fully account for the slowdown. The unemployment rate declined from about 

9 percent last summer to a still-elevated 8Y. percent in 

January, and it has remained close to that level since 

then. Likewise, long-term joblessness has shown little 

net improvement this year, with the share of those 

unemployed persons who have been jobless for 

six months or longer remaining around 40 percent. 

Further meaningful reductions in unemployment are 

likely to require some pickup in the pace of economic 

activity. 

Consumer price inflation moved down. on net, during the first half of the year. The price index for overall 

personal consumption expenditures (PCE) rose rapidly 

in the first three months of the year, reflecting large 

increases in oil prices, but inflation turned down in the 

spring when oil prices more than reversed their earlier 

run-ups. In all, the PCE price index increased at an 

annual rate of about 1 V, percent over the first 

five months of the year, compared with a rise of 

2V, percent during 2011. Excluding food and energy, 

consumer prices rose at about a 2 percent rate over the 

first five months of the year, close to the pace recorded 

over 2011. In addition to the net decline in crude oil 

prices over the first half of the year, factors contributing to low consumer price inflation this year inclnde 

the deceleration of non-oil import prices in the latter 

part of 2011, subdued labor costs associated with the 

weak labor market, and stable inflation expectations. 

In the household sector, credit conditions have generally remained tight for all but highly rated borrowers; 

among other factors, this tightness rellects the uncertain economic outlook and the high unemployment 

rate. Total mortgage debt decreased further as the pace 

of mortgage applications to purchase a new home was 

sluggish. Refinancing activity increased over the course 

of the second quarter but remained below levels 

reached in previous refinancing booms despite historically low mortgage interest rates. The increase in refinancing was partially attributable to recent enhancements made to the Home Affordable Refinance 

Program that appeared to boost refinancing activity 

somewhat for borrowers with underwater mortgagesthat is, for those who owed more on their mortgages 

than their homes were worth. Consumer credit 

expanded moderately mainly because of growth in federal student loans. 

Firms in the nonfinancial corporate sector continued 

to raise funds at a generally moderate pace in the first 

half of the year. Those with access to capital markets 

took advantage of low interest rates to refinance existing debt. As a result, corporate debt issuance was solid 

over the first part of the year, although issuance of 

speculative-grade corporate bonds weakened notably 

in June as investors pulled back from riskier assets. 

Commercial and industrial loans on the books of 

banks expanded briskly, but borrowing conditions for 

small businesses have improved more slowly than have 

those for larger firms. Financing conditions for commercial real estate stayed relatively restrictive, and fundamentals in that sector showed few signs of 

improvement. 

Market sentiment toward major global banks lIuctuated in the first half of 2012. In March, the release of 

the results from the Comprehensive Capital Analysis 

and Review, which investors interpreted as indicating 

continued improvements in the health of domestic 

banks, provided a significant boost to the equity prices 

of U.S. financial institutions. Those gains partially 

reversed when market sentiment worsened in May, 

driven in large part by concerns about Europe and 

potential spillovers to the United States and its fmancial institutions. On balance, however, equity prices of 

banks rose significantly from relatively low levels at the 

start of the year. An index of credit default swap 

spreads for the large bank holding companies declined 

about 60 basis points, but those spreads remained at a 

high level. Despite the swings in market sentiment 

about global banking organizations, conditions in 

unsecured short-term dollar funding markets were 

fairly stable in the first half of 2012. European financial institutions have reduced their demand for dollar 
73 


76116.018

funding over recent quarters, and general funding pressures apparently were alleviated by the ECB's longerterm refinancing operations. 

With the Committee anticipating only slow progress 

in bringing unemployment down toward levels that it 

judges to be consistent with its dual mandate and 

strains in global financial markets continuing to pose 

significant downside risks to the economic outlook, the 

FOMC took additional steps to augment the already 

highly accommodative stance for monetary policy during the first half of 2012. In January, the Committee 

modified its forward rate guidance, noting that economic conditions were likely to warrant exceptionally 

low levels for the federal funds rate at least through late 

2014. And in June, the FOMC decided to continue the 

MEP until the end of the year rather than completing 

the program at the end of June as previously 

scheduled. 

The June Summary of Economic Projections is presented in Part 4 of this report. At the time of the Committee's June meeting, FOMC participants (the 

7 members of the Board of Governors and the presidents of the 12 Federal Reserve Banks) saw the 

economy expanding at a moderate pace over coming 

quarters and then picking up gradually under the 

assumption of appropriate monetary policy. Most participants marked down their projections for economic 

growth in 2012 and 2013 relative to what they anticipated in January and April largely as a result of the 

adverse developments in Europe and the associated 

effects on financial markets. Moreover, headwinds from 

the fiscal and financial situation in Europe, from the 

still-depressed housing market, and from tight credit 

for some borrowers were cited as likely to hold back 

the pace of economic expansion over the forecast 

period. 

FOMC participants also projected slower progress 

in reducing unemployment than they had anticipated 

Board of Governors of the Federal Reserve System 3 

in January and April. Committee perticipants' projections for the unemployment rate had a central tendency of 8.0 to 8.2 percent in the fourth quarter of this 

year and then deClined to 7.0 to 7.7 percent at the end 

of 2014; those levels are still generally well above participants' estimates of the longer-run normal rate of 

unemployment. Meanwhile, participants' projections 

for inflation had a central tendency of 1.2 to 1.7 percent for 2012 and 1.5 to 2.0 percent for both 2013 and 

2014; these projections are lower, particularly in 2012, 

than participants reported in January and April, in 

part reflecting the effects of the recent drop in crude oil 

prices. 

With the unemployment rate expected to remain 

elevated over the projection period and inflation generally expected to be at or under the Committee's 2 percent objective, most participants expected that, nnder 

their individual assessments of appropriate monetary 

policy, the federal funds rate would remain extraordinarily low for some time. In particular, II of the 

19 participants placed the target federal funds rate at 

0.75 percent or lower at the end of 2014; only 4 of 

them saw the appropriate rate at 2 percent or higher. 

All participants reported levels for the appropriate target federal funds rate at the end of 2014 that were well 

below their estimates of the level expected to prevail in 

the longer run. In addition to projecting only slow 

progress in bringing down unemployment, most participants saw the risks to the outlook as weighted 

mainly toward slower growth and higher unemployment. In particular, participants noted that strains in 

global financial markets, the prospect of rednced fiscal 

accommodation in the United States, and a general 

slowdown in global economic growth posed significant 

risks to Ibe recovery and to a further improvement in 

labor market conditions. 
74 


76116.019

Part 2 

Recent Economic and Financial Developments 

Economic activity appears to have expanded at a 

somewhat slower pace over the first half of 2012 than 

in the second half of 2011. After rising at an annual 

rate of 2\1, percent in the second half of 2011, real 

gross domestic product (GDP) increased at a 2 percent 

pace in the first quarter of 2012, and available indicators point to a still smaller gain in the second quarter 

(figure I), An important factor influencing economic 

and financial developments this year is the unfolding 

fiscal and banking crisis in Europe. Indeed, the economic outlook for the second half of 2012 depends 

crucially on the extent to which current and potential 

disruptions in Europe directly reduce US. net exports 

and indirectly curtail private domestic spending 

through adverse spillover effects on US. financial markets and institutions and on household and business 

confidence. At the same time, the economy continues 

to face other headwinds, including restricted access to 

some types of household and small business credit, a 

still sizable inventory of vacant homes, and lessaccommodative fiscal policy. 

The labor market remains weak. Private payroll 

employment stepped up early in the year but then 

slowed in the second quarter (though those moves may 

have been exaggerated by issues related to swings in the 

I. Change in real gross domestic produc~ 2006-12 

Percenl, annua! rate 

I I I I I I 2006 2007 2008 2009 2010 2011 2012 

NOTE: Here and in subsequent figures, except as noted, change for a given 

period is measured to its final quaner from the final quarter of the preceding 

period. 

SOURCE: Department of Commerce, Bureau of Economic Analysis. 

weather and to seasonal adjustment), and the unemployment rate hovered around gy. percent after a significant decrease over the latter months of 20 II and in 

January. Meanwhile, consumer price inflation, in part 

buffeted by sharp swings in the price of gasoline, 

stepped up early in the year but subsequently turned 

down, and longer-term inflation expectations remained 

stable (figure 2). 

Financial markets were somewhat volatile over the 

first half of 2012 mostly due to fluctuating views 

regarding the crisis in the euro area and the likely pace 

of economic gro~th at home and abroad. Yields on 

longer-term Treasury securities have declined significantly, reflecting greater monetary policy accommodation, the weaker outlook, and safe-haven flows. Broad 

indexes of US. equity prices rose, on net, risk spreads 

on corporate bonds were generally unchanged or 

slightly lower, and unsecured short-term dollar fnnding 

markets were fairly stable. Debt issuance by US. corporations was solid, and bank lending to larger firms 

was brisk. In the household sector, consumer credit 

expanded and mortgage refinancing activity increased 

modestly, reflecting the decline in mortgage rates to 

historically low levels as well as recent changes to the 

Home Affordable Refinance Program (HARP). 

2. Change in the chain-type price index for personal 

consumption expenditures, 2006-12 

-4 

- 3 

+ 

--------------~~--------------o 

I I 2006 2007 2008 2009 2010 2011 2012 

NOTE: The data are monthly and extend through May 2012; changes are 

from one year earlier. 

SOURCE: Department of Commerce, Bureau of Economic Analysis. 
75 


76116.020

6 Monetary Policy Report to the Congress 0 July 2012 

Domestic Developments 

The Household Sector 

Consumer SJlending and Hou,vehold Finance 

After rising at an annual rate of about 2 percent in the 

second half of 2011, real personal consumption expenditnres (PCE) increased 2V, percent in the first quarter, 

but available information suggests that real PCE decelerated some in the second quarter (figure 3). The firstquarter increase in spending oceurred across a broad 

array of goods and services with the notable exception 

of outlays for energy services, which were held down 

by reduced demand for heating because of the unseasonably warm winter. Spending on energy services 

appears to have rebounded in the second quarter as the 

temperate winter gave way to a relatively more typical 

spring. In contrast, the pace of motor vehicle sales 

edged down in the second quarter, and reports on 

retail sales suggest that consumer ontlays on a wide 

range of items rose less rapidly than they did in the 

first quarter. The moderate rise in consumer spending 

over the first half of the year occurred against the 

backdrop of the considerable economic challenges still 

facing many households, including high unemployment, sluggish' gliins in employment, tepid growth in 

income, still-stressed balanced sheets, tight access to 

some types of credit, and lingering pessimism about 

job and income prospecta With increases in spending 

outpacing growth in income so far this year, the personal saving rate continued to decline, on net, though it 

remained well above levels that prevailed before the 

recession (figure 4). 

3. Change in real personal consumption expenditures. 

2006-12 

PcrcclIl,annualrate 

I I QI 

• HI H21 

+ 

I 

II 0 

I I I I 2006 2007 2008 2009 2010 2011 2012 

NOTE: The data are quarterly and extend through 2012:QL 

SOURCE: Department of Commerce. Bureau of Economic Analysis, 

4. Personal saving rate, 1992-2012 

!'=<n. 

-----------------------------

- 3 

+ 

----------------------------- 0 

! ! ! I I I I I ! L....L! I 1 11 I ! ! J I! ! 

1992 1996 2000 2004- 2008 2012 

NOTE: The data are quarterly and extend througb 2012:Q2; the reading for 

2012:Q2 is the average for April and May. 

SOURCE: Department of Commerce, Bureau of Economic Analysis. 

Aggregate real disposable personal income (DPI}-

personal income less personal taxes, adjusted for 

changes in prices-rose more rapidly over the first five 

months of the year than it did in 2011, in part because 

of declining energy prices (figure 5). The wage and salary component of real DP!, which reflects both the 

number of hours worked and average hourly wages 

adjusted for inflation, rose at an annual rate of nearly 

1 V. percent through May of this year after having 

increased at a similar pace in 2011. The increase in real 

wage and salary income so far in 2012 is largely attributable to the modest improvement in employment and 

5. Change in real disposable personal income and in real 

wage and salary disbursements, 2006-12 

Percent, annual mte 

+ --------~--""'--f-.f------=------o 

I I 

Real wage and salary disbursemems 

2006 2007 2008 2009 2010 2011 2012 

I I 

NOTE: "Through 2011, change is from December to December; for 2012, 

change is from December to May. The real wage and salary disbursements 

series is nominal wage and salary disbursements deflated by the personal 

consumption expenditures deflator, 

SOURCE: Department of Commerce, Bureau of Economic Analysis. 
76 


76116.021

hours worked; real average hourly earnings are little 

changed thus far this year. 

The ratio of household net worth to income, in the 

aggregate, moved up slightly further in the first quarter, 

reflecting increases in both house prices and equity 

prices (figure 6). Taking a longer view, this ratio has 

been on a slow upward trend since 2009, and while it 

remains far below levels seen in the years leading up to 

the recession, it is about equal to its average over the 

past 20 years. Household-level data through 20 to indicate that wealth losses were proportionately larger for 

the middle portion of the wealth distribution-not a 

surprising result, given the relative importance of 

housing among the assets of those households Meanwhile, indicators of consumer sentiment are above 

their lows from last summer but have yet to return to 

pre-recession levels (figure 7). 

Household debt-the sum of mortgage and consumer debt-edged down again in the first quarter of 

2012 as the continued contraction in mortgage debt 

was almost offset by solid expansion in consumer 

credit. With the reduction in household debt, low level 

of most interest rates, and modest growth of income, 

the debt-service ratio-the aggregate required principal 

and interest payments on existing household debt relative to income-decreased further, and, at the end of 

the first quarter, it stood at a level last seen in 1994 

(figure 8). 

Consumer credit expanded at an annual rate of 

about 6\4 percent in the first five months of 2012, 

driven by an increase in nonrevolving credit. This component accounts for about two-thirds of total consumer credit and primarily consists of auto and stu6. Wl'3lth-to-income ratio, 1992-2012 

_________________ --"R.atio 

- 7 

-4 

1 ! ! J ! , I I I I I ! I ! ! ! ! I ! ! ! ! I 1 

1992 1996 2000 2004 2008 2012 

NOTE: The data are quarterly and extend through 2012:QL The wealth· 

to-income ratio is the ratio of household net worth to disposable personal 

income. 

SOURCE: For net worth, Federal Reserve Board. flow of funds data; for 

income, Department of Commerce. Bureau of Economic Analysis. 

Board of Governors of the Federal Reserve System 7 

7. Consumer sentiment indexes. 2002-12 

140 

Conference Board 120 

100 

80 

60 

40 

20 

! ! ! ! I I I 2003 2006 2009 2012 

NOTE: The Conference Board. data are monthly and extend through lune 

2012; the series is inde,;ed to equal 100 in 1985. The Thomson 

Reuters/University of Michigan data are monthly and extend through a 

preliminary estimate for July 2012; the series is indexed to equal 100 in 1966. 

SOURCE: The Conference Board and Thomson ReuterslUniversity of 

Michigan Surveys of Consumers. 

dent loans. The rise in nonrevolving credit so far this 

year was primarily due to the strength in student loans, 

which were almost entirely originated and funded by 

the federal government. Meanwhile, auto loans maintained a steady pace of increase. Revolving consumer 

credit (primarily credit card lending) remained much 

more subdued in the first five months of the year in 

part because nonprime borrowers continued to face 

tight underwriting standards. Overall, the increase in 

consumer credit is consistent with recent responses to 

the Senior Loan Officer Opinion Survey on Bank 

Lending Practices (SLOOS) indicating that demand 

8. Household debt service, 1984-2012 

Percent of di!lJlOsab!:e income 

14 

13 

12 

11 

! ! I!!! j I!!!! III II! I!! II! III!! I 

1984 1988 1992 19% 2000 2004 2008 2012 

NOTE: The data are quarterly and e,;tend through 2012:Q1. Debt service 

payments consist of estimated required payments on outstanding mortgage and 

consumer debt. 

SO\lRCE: Federal Reserve Board, "Household Debt Service and Financial 

Obligations Ratios," statistical release. 
77 


76116.022

i j 
78 


76116.023

10. Private housing starts, 2002-12 

MiHionsofllnlts,aIDlualrate 

1.4 

1.0 

Single-family 

Multifamily .6 

.2 

of the year, new multifamily projects were started at an 

average annual rate of about 225,000 units, up from 

about 200,000 in the second half of 20 11 but still 

below the 300,OOO-unit rate that prevailed for much of 

the previous decade. 

House prices, as measured by several national 

indexes, turned up in recent months after edging down 

further, on balance, in 2011 (figure II). For example, 

the Core Logic repeat-sales index rose 4 percent (not an 

annual rate) over the first five months of the year. This 

recent improvement notwithstanding, this measure of 

house prices remains 30 percent below its peak in 2006. 

11. Prices of existing single-family houses, 2001-12 

Index value 

100 

90 

80 

70 

60 

50 

S&I?IO,,,-,;hill,,, and FHF A data are monthly and extend 

through April CoreLogic data are monthly and extend through 

May 2Q12. Each index has been normalized so that its peak is 100. Both the 

CoreLogic price index and the FHFA index (formerly calculated by the 

Office of Federal Housing Enterprise Oversight) include purchase 

transactions only. The S&P/Case~Shmer index reflects all ann's~length sales 

transactions in selected metropolitan areas. 

SOURCE: For CoreLogic, CoreLogic; for FHF A, Federal Housing Finance 

Agency~ for S&P/Case-Shiller, Standard & Poor's, 

Board of Governors of the Federal Reserve System 9 

The same factors that are restraining single-family 

housing construction also continue to weigh on house 

prices, including the large inventory of vacant homes, 

tight mortgage credit conditions, and lacklnster 

demand. 

Mortgage rates declined to historically low levels 

during the first half of 2012 (figure 12). While significant, the drop in mortgage rates generally did not keep 

pace with the declines in the yields on Treasury and 

mortgage-backed securities (MRS), probably refiecting 

still-elevated risk aversion and some capacity constraints among mortgage originators. Despite the drop 

in mortgage rates, many potentially creditworthy borrowers have had difficulty obtaining mortgages or refinancing because of tight standards and terms (sec the 

box "The Supply of Credit"). Another factor impeding the ability borrowers to refinance, or to sell their home purchase a new one, 

has been the prevalence of underwater mortgages. 

Overall, refinancing activity increased in the second 

quarter but was still less than might be expected, givcn 

the level of interest rates, and the pace of mortgage 

applications for home purchases remained sluggish. 

However, refinancing activity attributed to recent 

changes to the HARP---one of which eliminated caps 

on loan-to-value ratios for those who were refinancing 

mortgages already owned by government-sponsored 

enterprises (GSEs)---has picked up over the first half 

of the year. 

Indicators of credit quality in the residential mortgage sector continued to reflect strains on homeowners 

confronting depressed home values and high unemployment. The fraction of current prime mortgages 

becoming delinquent remained at a high level but 

12. Mortgage interest rates. 1995-2012 
79 


76116.024

10 Monetary Policy Report to the Congress July 2012 

The ,\!uu..-.,:>e,,, Credit 

Access to mortgage credit is among the important 

factors that affect the demand for housing and thus 

the recovery in the housing sector. lending standards appear to be considerably tighter than they 

were even before the housing boom, likely preventing many households from purchasing homes. 

According to the Senior loan Officer Opinion 

SUfVeyon Bank lending Practices (SLOOS), from 

mid-200? into 2009, many lenders tightened their 

standards for residential mortgages originated to 

borrowers with prime credit scores, and very few 

higher-rated borrowers in 2008 (figure H). The upward shift in credit 

scores is also evident for prime borrowers who refinanced theif mortgages and for Federal Housing 

Administration mortgages. 

A. Net percentage of domestic respondents tightening standards for residential mortgage loans, 1990--2012 

inched lower, on net, over the first five months of the 

year, likely reflecting in part stricter underwriting of 

more-recent originations, Additionally, measures of 

late-stage mortgage delinquency, such as the inventory 

of properties in foreclosure, continued to linger near 

the peak in the first of 2012 (figure J 3). 

Gross issuance by GSEs 

remained moderate in the first half of 2012, consistent 

with the slow pace of mortgage originations. In contrast, the securitization market for mortgage loans not 

guaranteed by a hOUSing-related GSE or the Federal 

Housing Administration-an important source of 

funding before the crisis for prime-grade mortgages 

that exceeded the conforming loan size limit--continued to be essentially dosed. 

The Business Sector 

Fixed Illvestmellt 

JOO 

Real business spending for equipment and software 

(E&S) rose at an annual rate of 311, percent in tbe first 

quarter of 2012 after having risen at a double-digit 

pace, on aveFdge, in the second half of 2011 (figure 14), 

The slowdown in E&S investment growth in the first 

quarter was fairly widespread across categories of 

equipment and software. This deceleration in E&S 

spending along with the recent softening in indicators 

of investment demand, such as surveys of business 

sentiment and capital spending plans, may signal some 
80 


76116.025

&kJik1i&J 

IIlIil I 1_1Ii1l Ii i!i¥I"& El:1IU 
81 


76116.026
82 


76116.027
83 


76116.028

14 Monetary Policy Report to the Congress 0 July 2012 

19. Net percentage of finns with borrowing needs, 1994--2012 

Percent 

I I ! I ! ! I ! ! ! ! ! ! I ! I ! I I I I I 

1996 2000 2004 2008 2012 

NOTE: The data are drawn from a survey conducted monthly and are 

seasonally adjusted; the last observation is from the June 2012 survey. The 

data represent the proportion of businesses with borrowing needs over the 

past three months regardless of whether those needs were satisfied or not 

satisfied. TItis number is seasonally adjusted. 

SOURCE: National Federation of Independent Business. 

three months earlier and that expected tighter credit 

conditions over the next three months have both 

declined, but they remained at relatively high levels in 

the June survey. In addition, recent readings from the 

STBL indicate that the spreads charged by commercial 

banks on newly originated C&I loans with original 

amounts less than $1 million remained quite high, even 

on loans with the strongest credit ratings. 

Financial conditions in the commercial real estate 

(CRE) sector have eased some but stayed relatively 

tight amid weak fundamentals. According to the April 

SLOOS, some domestic banks reported having eased 

standards on CRE loans and, on balance, a significant 

number of domestic banks reported increased demand 

for such loans. While banks' holdings of CRE loans 

continued to contract in the first half of this year, they 

did so at a slower pace than in the second half of last 

year. The weakest segment of CRE lending has been 

the portion supporting construction and land development; some other segments have recently expanded 

modestly. Issuance of commercial mortgage-backed 

securities (CMBS) has also increased recently from the 

low levels observed last year. Nonetheless, the delinquency rate on loans in CMBS pools continued to set 

new highs in June, as some five-year loans issued in 

2007 at the height of the market were unable to refinance at maturity because of their high loan-to-value 

ratios (figure 20). While delinquency rates for CRE 

loans at commercial banks improved slightly in the first 

quarter, they remained elevated, especially for construction and land development loans. 

In the corporate equity market, gross public equity 

issuance by nonfinancial firms was strong in the first 

20. Delinquency rates on commercial real estate loans, 

1991-2012 

_C~o:::m:::m~e~rc:::·ia1:::.:.b.::an~ks=--___________ Percenl 

20 

Multifamily 

IS 

10 

- 5 

! ! I I I! ! I I I t I I ! ! I ! I! ! ! I ! 

1991 1994 1997 2000 2003 2006 2009 2012 Percent 

10 

8 

2 

+ 

o I I I j I I I ! I I I I I I I I ! ! ! I I I I I I -

1991 1994 1997 2000 2003 2006 2009 2012 

NOTE; The data for commercial banks and life insurance companies are 

quarterly and extend through 2012:Ql. The data for commercial 

mortgage-backed securities (CMBS) are monthly and extend through 

June 2012. The delinquency rates for commercial banks and CMBS are the 

percent of Joans 30 days or more past due or not accruing interest The 

delinquency rate for life insurance companies is the percent of loans 60 days 

or more past due or not accruing interest. 

SOURCE: For commercial banks, Federal Financial Institutions 

Examination Council. Consolidated Reports of Condition and Income (Call 

Report); for 1ife insurance companies. American Council of Life Insurers; for 

CMBS. Citigroup. 

five months of 2012, boosted by a solid pace of initial 

public offerings (IPOS)4 Data for the first quarter of 

2012 indicate that share repurchases and cash-financed 

mergers by nonfinancial firms remained robust, and 

net equity issuance remained deeply negative (figure 21). However, fewer mergers and new share repurchase programs were announced in the second quarter. 

The Government Sector 

Federal Goverll1nenf 

The deficit in the federal unified budget remains 

elevated. The Congressional Budget Office projects 

that the deficit for fiscal year 2012 will be close to 

$1.2 trillion, or about 7Y, percent of nominal GOP. 

Such a deficit would be a narrower share of GOP than 

those recorded over the past several years though still 

4. Indeed, the second largest lPO on record began trading in 

mid-May. However, the price performance of those shares in the days 

following that offering was sharply negative on net, and IPO activity 

subsequently weakened significantly. 
84 


76116.029
85 


76116.030

16 Monetary Policy Report to the Congress 0 July 2012 

23. Change in real government expenditures 

on consumption and investment, 2006--12 

Percent, annual rnte 

o Fodernl 

III State and local 12 

~L~_9 

- 6 

SOURCE: Department of Commerce, Bureau of Economic Analysis. 

State and Local GOI'ernment 

State and local government budgets remain strained, 

but overall fiscal conditions for these governments may 

be slowly improving. In particular, state and local tax 

receipts appeared to increase moderately over the first 

half of this year. Census Bureau data indicate that 

state revenue collections rose 4 percent in the first 

quarter relative to a year earlier, and anecdotal evidence suggests that collections during April and May 

were well maintained. Moreover, only a few states 

reported budget shortfalls during fiscal 2012 (which 

ended on June 30 in most states). The improvement is 

less evident at the local level, where property tax 

24. Federal government debt held by the public, 1960-2012 

PeTCI.'hl of nominal GDP 

70 

60 

50 

40 

30 

20 

Llw.l.lll III 11! 11111111 jill j II i III!I I! III II! Ij! I!I! II!! 

1962 1972 1982 1992 2002 2012 

NOTE: The data for debt through 2011 are as of year-end. and the 

corresponding values for gross domestic product (GDP) are for Q4 at an 

annual rate. The observation for 2012:Q2 is based on an estimate for debt in 

[hat quarter and GOP iu the frrst quarter. Excludes securities held as 

investments of federal government accounts.. 

SOURCE: Federal Reserve Board, flow of funds data. 

receipts--the largest source of tax revenue for these 

governments--were roughly flal in 2011 and early 

2012, reflecting the crosscutting effects of the earlier 

declines in home prices and increases in property tax 

rates. Moreover, federal aid to both state and local governments has declined as stimulus-related grants have 

been almost completely phased out. 

One of the ways that state and local governments 

have addressed their tight budget situations has been 

through cuts in their employment and construction 

spending. After shedding jobs at an average pace of 

19,000 per month in 2011, these governments reduced 

their employment over the first half of the year at a 

slower pace hy trimming 3,000 jobs per month on average. However, real construction expenditures fell 

sharply in the first quarter after having edged down in 

the latter half of 2011, and available information on 

nominal construction spending throngh May points to 

continued declines in recent months. The decreases in 

employment and construction are evident in the 

Bureau of Economic Analysis (BEA) estimate for real 

state and local purchases, which fell at an annual rate 

of 2% percent in the first quarter, about the same pace 

as in 2011. 

Gross issuance of bonds by states and municipalities 

picked up in the second quarter of 2012. Credit quality 

in the sector continued to deteriorate over the first half 

of the year. For instance, credit rating downgrades by 

Moody's Investors Service substantially outpaced 

upgrades, and credit default swap (CDS) indexes for 

municipal bonds rose on net. Yields on long-term general obligation mnnicipal bonds were abont nnchanged 

over the first half of the year. 

The External Sector 

ExpIJI'ts and Imports 

Both real exports and imports grew moderately in the 

first quarter of 2012 (figure 25). Real exports of goods 

and services rose at an annual rate of 4V4 percent, sup~ 

ported by relatively strong foreign economic growth. 

Exports of services, automobiles, compnters, and aircraft expanded rapidly, while those of consumer goods 

declined. The rise in exports was particularly strong to 

Canada and Mexico. Data for April and May suggest 

that exports continued to rise at a moderate pace in the 

second quarter. 

Real imports of goods and services rose a relatively 

modest 2% percent in the first quarter, reflecting slower 

growth in US. economic activity. Imports of services, 

automobiles, and computers rose Significantly, while 
86 


76116.031

25. Change in real imports and exports of goods 

and services, 2007-12 

Percent, annual rate 

I I 

o Imports 

II Exports 

2007 2008 2009 2010 2011 2012 

I I 

SOURCE: Department of Commerce, Bureau of Economic Analysis. 

15 

10 

those of petroleum, aircraft, and consumer goods feH. 

The rise in imports was broadly based across major 

trading partners, with imports from Japan and Mexico 

showing particularly strong growth. April and May 

data suggest that import growth picked up in the second quarter. 

Altogether, net exports made a small positive contribution of one-tenth of 1 percentage point to real GDP 

growth in the first quarter. 

Commodity and Trade Prices 

After increasing earlier in the year, oil prices have subsequently fallen back (figure 26). Over much of the first 

quarter, an improved outlook for the global economy 

and increased geopolitical tensions-most notably with 

Iran-helped spur a run-up in the spot price of oil, 

with the Brent benchmark averaging $125 per barrel in 

March, about $15 above its January average. Since 

mid-March, however, oil prices have more than 

retraced their earlier gains amid an intensification of 

the crisis in Europe and increased concerns over the 

strength of economic growth in China. An easing of 

geopolitical tensions and increased crude oil supplyproduction by Saudi Arabia has been running at nearrecord high levels-have also likely contributed to the 

decline in oil prices. All told, the price of Brent has 

plunged $25 a barrel from March to about $100 per 

barrel in mid-July. 

Prices of many nonfuel commodities followed a path 

similar to that shown by oil prices, albeit with less volatility. Early in 2012, commodity prices rallied, as global 

economic prospects and financial conditions improved 

Board of Governors of the Federal Reserve System 17 

26. Prices of oil and nonfuel commodities, 2007-12 

December 2006 '" 100 Dollars pet barre! 

160 141) 

120 141) 

100 

120 

80 

100 60 

80 41) 

I I I I 

2007 2008 2!lO9 2010 2011 2012 

NOTE: The data are monthly. The oil price is the spot price of Brent crude 

oil, and the last observation is the average for 

July I-B. 2012. The price of nonfuel commodities is an index of 

45 primary...commodity prices and extends through June 2012. 

SOURCE: For oil, the Commodity Research Bureau; for nonfuel 

commodities, international Monetary Fund. 

along with a temporary abatement of stresses in 

Europe. However, as with oil prices, broader commodity prices fell in the second quarter, rellecting growing 

pessimism regarding prospects for the global economy. 

Prices for non-oil imported goods increased less 

than Y. percent in the first quarter, with the modest 

pace of increase likely rellecting the lagged effects of 

both the appreciation of the dollar and the decline in 

commodity prices that occurred late last year. Moving 

into the second qnarter, import price inllation appears 

to have remained subdued, consistent with a further 

appreciation of the dollar. 

The Current and Financial Accounts 

Largely rellecting the run-up in oil prices early in the 

year, the nominal trade deficit widened slightly in the 

first quarter (figure 27). In addition, as the net investment income balance continued to decline, the current 

account deficit deteriorated from an annual average of 

$470 billion in 2011 to $550 billion in the first quarter, 

or 3\1, percent of GDp'6 

The financial llows that provide the financing of the 

current account deficit reflected the general trends in 

financial market sentiment and in reserve accumulation 

6. In 1999, the BEA-white revisiting its methodology for the 

balance of payments accounts-redefined the current account to 

exclude capital transfers, In the process, the capital account was 

renamed the financial account, and a newly defined capital account 

was created to include capital transfers as well as the acquisition and 

disposal of nonproduced nonfinancial assets. 
87 


76116.032
88 


76116.033
89 


76116.034

20 Monetary Policy Report to the Congress 0 July 2012 

33. Civilian unemployment rate. 1982-2012 

_________________ --.:.:Percent 

12 

10 

- 8 

- 4 

I I! IIIII!! I! III! III I!! II!!! II t! II 

1988 19% 2004 2012 

NOTE: The data are monthly and extend through June 2012. 

SOURCE: Department of Labor, Bureau of Labor Statistics. 

Other labor market indicators were consistent with 

little change in overall labor market conditions during 

the first half of the year. Initial claims for unemployment insurance were not much changed, on net, 

although their average level over the first half of the 

year was lower than in the second half of 20 II. Measures of job vacancies edged up, on balance, and households' labor market expectations largely reversed the 

steep deterioration from last summer. However, indicators of hiring activity remained subdued. 

Productivity and Lahor Compensation 

Gains in labor productivity have continued to slow 

recently following an outsized increase in 2009 and a 

34. Long-term unemployed, 2006-12 

_________________ ~~~t 

50 

40 

30 

20 

10 

I I I I 2006 2007 2008 2009 2010 2011 2012 

NOTE: The data are monthly and extend through June 2012. The series 

shown is the percentage of tOlal unemployed persons who have been 

unemployed for 27 weeks Of more. 

SOURCE: Department of Labor, Bureau of Labor Statistics. 

solid gain in 2010. According to the latest published 

data, output per hour in the nonfarm business sector 

rose just Y, percent in 2011 and declined in the first 

quarter of 2012 (figure 35). Although these data can be 

volatile from quarter to quarter, the moderation in productivity growth over the past two years suggests that 

firms have been adding workers not only to meet rising 

production needs but also to relieve pressures on their 

existing workforces, which were cut back sharply during the recession. 

Increases in hourly compensation continue to be 

restrained by the very weak condition of the labor 

market. The 12-month change in the employment cost 

index for private industry workers, which measures 

both wages and the cost to employers of providing 

benefits, has been about 2 percent or less since the start 

of 2009 after several years of increases in the neighborhood of 3 percent (figure 36). Nominal compensation 

per hour in the nonfarm business sector-a measure 

derived from the labor compensation data in the 

NIPA-also decelerated significantly over the past few 

years; this measure rose just I Y. percent over the year 

ending in the first quarter of 2012, well below the average increase of about 4 percent in the years before the 

recession. Similarly, average hourly earnings for all 

employees-the timeliest measure of wage developments-rose about 2 percent in nominal terms over the 

12 months ending in Jnne. According to each of these 

measures, gains in hourly compensation failed to keep 

up with increases in consumer prices in 2011 and again 

in the first quarter of this year. 

The change innnit labor costs faced by firmswhich measures the extent to which nominal hourly 

35. Change in output per hour, 1948-2012 

Pe:rcent,annual rnle 

-6 

-1 

I I I !!! I I I I ! I 

1948- 1974- 1996- 2001- 2006 2008 2010 2012 73 95 2000 04 

NoTE: Nonfann business sector. Change for each mUltiyear period is 

measured to the fourth quarter of the final year of the period from the fourth quarter of the year immediately preceding the period. 

SOURCE: Department of Labor, Bureau of Labor Statistics. 
90 


76116.035

36. Measures of change in hourly compensation. 

2002-12 

Percenl 

NOTE: The data are quarterly and extend through 2012:QI. For nonfarm 

business compensation, change is over four quarters; for the employment cost 

index (Eel), change is over the 12 months ending in the last month of each 

quarter. The nonfarm business sector excludes farms, government. nonprofit 

institutions. and households. The sector covered by the Eel used here is the 

nonfarm business sector plus nonprofit institutions. 

SOURCE: Depanment of Labor, Bureau of Labor Statistics. 

compensation rises in excess of labor productivityremained subdued. Unit labor costs iu the nonfarm 

business sector rose 1 percent over the year ending in 

the first quarter of 2012. Over the preceding year, unit 

labor costs increased 1 Y, percent. 

Prices 

Consumer price inflation moved down, on net, during 

the first part of 2012. Overall PCE prices rose rapidly 

iu the first three months of the year, reflecting large 

increases in oil prices, but inflation turned down in the 

spring as oil prices more than reversed their earlier 

run-ups. The overall chain-type PCE price index 

increased at an annual rate of about 1 Y, percent 

between December 2011 and May 2012, compared 

with a rise of 2Y, percent over 2011 (figure 37). Excluding food and energy, consumer prices rose at a rate of 

about 2 percent over the first five months of the year, 

essentially the same pace as in 2011. In addition to the 

net decline in crude oil prices over the first half of the 

year, factors contributing to low consumer price inflation this year include the deceleration of non-oil 

import prices in the latter part of 2011, subdued labor 

costs associated with the weak labor market, and stable 

inflation expectations. 

Consumer energy prices surged at an annual rate of 

over 20 percent in the first three months of 2012, as 

higher costs for crude oil were passed through to gasoline prices. In April, the national-average price for 

Board of Governors of the Federal Reserve System 21 

37. Change in the chain-type price index for personal 

consumption expenditures, 2006-12 

Percent, annual rate 

o Total 

• Excluding food and energy - 5 

-4 

NOTE: Through 2011. change is from December to December; for 2012, 

change is from December to May. 

SOURCE: Department of Commerce, Bureau of Economic Analysis. 

gasoline at the pump approached $4 per gallon. Since 

then, crude oil prices have tumbled, and gasoline prices 

have declined roughly in line with crude costs, more 

than reversing the earlier run-up. Consumer prices for 

natural gas plunged over the first five months of the 

year after falling late last year; this drop is attributable, 

at least in part, to the unseasonably warm winter, 

which reduced demand for natural gas. More recently, 

spot prices for natural gas have turned up as production has been cut back, but they still remain substantially lower than they were last summer. 

Consumer food price inflation has slowed noticeably 

so far this year, as the effect on retail food prices from 

last year's jump in farm commodity prices appears to 

have largely dissipated. Indeed, PCE prices for food 

and beverages only edged up slightly. rising at an 

annual rate of about Y, percent from December to May 

after increasing more than 5 percent in 2011. Although 

farm commodity prices were tempered earlier this year 

by expectations of a substantial increase in crop output 

this growing season. grain prices rose rapidly in late 

June and early July as a wide swath of the Midwest 

experienced a bout of hot, dry weather that farm analysts believe cut yield prospects considerably. 

Survey-based measures of near-term inflation expectations have changed little, on net, so far this year. 

Median year-ahead inflation expectations, as reported 

in the Thomson Reuters/University of Michigan Surveys of Consumers (Michigan survey), rose in March 

when gasoline prices were high but then fell back as 

those prices reversed course (figure 38). Longer-term 

expectations remained more stable. In the Michigan 

survey, median expected inflation over the next 5 to 
91 


76116.036

22 Monetary Policy Report to the Congress 0 July 2012 

38. Median inflation expectations, 2001-12 

Percent 

Next 12 months 

- 5 

-4 

+ 

---------------------------------- 0 

! I I 1 It! 1 ! I I I j I 

2002 2004 2006 2008 2010 2012 

NOTE: The data are monthly and extend through a preliminary estimate for 

July 2012. 

SOURCE: Thomson ReutersJUniversity of Michigan Surveys of Consumers. 

10 years was 2.8 percent in early Jnly, within the narrow range of the past 10 years. In the Snrvey of Professional Forecasters, condncted by the Federal 

Reserve Bank of Philadelphia, expectations for the 

increase in the price index for PCE over the next 

10 years remained at 2'/. percent, in the middle of its 

recent range. 

Measures of medium- and longer-term inllation 

compensation derived from nominal and inllationprotected Treasury securities-which not only rellect 

inflation expectations, but also can be affected by 

changes in investor risk aversion and by the different 

liquidity properties of the two types of securities-- . 

were little changed, on net, so far this year (figure 39). 

These measures increased early in the period amid rising prices for oil and other commodities, but they subsequently declined as commodity prices feU back and 

as worries about domestic and global economic growth 

increased. 

Financial Developments 

Financial markets were somewhat volatile over the first 

half of 2012. Early in the year, broad equity price 

indexes rose and risk spreads in several markets narrowed as investor sentiment regarding short-term 

European prospects and the economic outlook 

improved. Those gains partially reversed when market 

participants became more pessimistic about the European situation and global growth prospects in May and 

June. Yields on longer-term Treasury securities 

declined, on balance, over the first half of the year. 

Conditions in unsecured short-term dollar funding 

39. Inflation compensation, 2007:-12 

__________________________________ -'Pc:. ercent 

5 to 10 years ahead 

=~ \ I' ! .I 

\ Ai I,j 

i; 5-year (carry adjusted) I 

- 3 

- 2 

-I 

I ! ! ! ! I ! ! , ! ! ! I I , ,! I j ! ! ! I I t I I 

2007 2008 2009 20!O 20 II 2012 

NOTE: The data are weekly averages of daily data and extend through 

July 13, 2012, Inflation compensation is the difference between yields on 

nominal Treasury securities and Treasury inflation-protected securities 

(fIPS) of comparable maturities, based on yield curves fitted by Federal 

Reserve staff to off4he-run nominal Treasury securities and on- and 

off-tbe-ruo TIPS, The 5-year measure is adjusted for the effect of indexation lags, 

SOURCE: Federal Reserve Bank of New York; Barclays; Federal Reserve 

Board staff estimates, 

markets generally remained stable as European financial institutions reduced their demand for dollar funding and general funding pressures were alleviated by 

the longer-term refinancing operations of the ECB. In 

the domestic banking sector, the release of the results 

from the Comprehensive Capital Analysis and Review 

(CCAR) in March provided a significant boost to the 

equity prices of US. financial institutions (see the box 

"The Capital and Liquidity Position of Large US. 

Banks"). 

Monetary Policy Expectations and 

Treasury Rates 

In response to the steps taken by the Federal Open 

Market Committee (FaMe) to provide additional 

monetary policy accommodation, and amid growing 

anxiety about the European crisis and a worsening of 

the economic outlook, investors pushed out further the 

date when they expect the federal funds rate to first rise 

above its current target range of 0 to y. percent. In 

addition, they apparently scaled back the pace at which 

they expect the federal funds rate subsequently to be 

increased. Market participants currently anticipate 

that the effective federal funds rate will be about 

50 basis points by the middle of 2015, roughly 55 basis 

points lower than they expected at the beginning of 

2012. 
92 


76116.037

Yields on longer-term nominal Treasury securities 

declined, on balance, over the first half of 2012 (figure 40). Early in the year, longer-term Treasury yields 

rose, reflecting generally positive U.S. economic data, 

improved market sentiment regarding the crisis in 

Europe, and higher energy prices. More recently, however, longer-term yields have more than reversed their 

earlier increases. Investors sought the relative safety 

and liquidity of Treasury securities as the crisis in 

Europe intensified again and as weaker-than-expected 

economic data releases raised concerns about the pace 

of economic recovery both in the United States and 

abroad. In addition, those developments fostered 

expectations that the Federal Reserve would provide 

additional accommodation. And the Treasury yield 

curve flattened further following the FOMC's decision 

at its June meeting to continue the maturity extension 

program (MEP) through the end of 2012. On balance, 

yields on 5-, 10-, and 30-year nominal Treasury securities declined roughly 20, 40, and 35 basis points, 

respectively, from their levels at the start of this year. 

The Open Market Desk's ontright purchases and sales 

of Treasury securities under the MEP did not appear 

to have any material adverse effect on Treasury market 

functioning. 

Short~Term Funding Markets 

Despite the reemergence of strains in Europe, conditions in unsecured short-term dollar funding markets 

have remained fairly stable in the first half of 2012. 

Measures of stress in short-term funding markets have 

eased somewhat, on balance, since the beginning of the 

40. Interest rates on Treasury securities at selected 

ptaturities. 2004-12 

Percent 

-4 

+ ---------------------------------- 0 

I! ! I I I ! 

2004 2006 2008 2010 

NOTE: The data are daily and extend through july 13, 2012, 

SOURCE: Department of the Treasury. 

I I 2012 

Board of Governors of the Federal Reserve System 23 

year. A few factors seem to have contributed to the 

relative stability of those markets. European institutions apparently reduced their demand for funds in 

recent quarters by selling dollar-denominated assets 

and exiting from business lines requiring heavy dollar 

funding. In additiou, European banks reportedly 

switched to secured funding supported by various 

types of collateral. Further, the availability of funds 

from the ECB through its longer-term refinancing 

operations likely helped reduce funding strains and the 

need to access interbank markets more generally. 

Reflecting these developments, the amount of dollar 

swaps outstanding between the Federal Reserve and 

the ECB has declined substantially from its peak earlier this year. 

Conditions in the CP market were also fairly stable. 

On uet, 30-day spreads of rates on unsecured A2lP2 

CP over comparable-maturity AA-rated nonfinancial 

CP declined a bit. The volume outstanding of unsecured financial CP issued in the United States by institutions with European parents decreased slightly in the 

first half of the year. The average maturity of unsecured financial CP issued by institutions with both U.S. 

and European parents is about 50 days, a level that is 

near the middle of its historical range (figure 41). 

Signs of stress were also largely absent in secured 

short-term dollar funding markets. In the market for 

repurchase agreements, bid-asked spreads for most 

collateral types were little changed. However, shortterm interest rates continued to edge up from the level 

observed around the turn of the year, likely reflecting 

in part the financing of the increase in dealers' inventories of shorter-term Treasury securities that resulted 

41. Average maturity for unsecured financial commercial 

paper outstanding in the United States, 2010-12 

___________________________________ D." 

Jan. July Jan. 

2010 2011 

70 

U.S, parent 

60 

50 

40 

European parent 30 

I! 

Jan. 

2012 

NOTE: The data are weekly and extend through July 11, 2012. 

SOURCE: Federal Reserve Board staff calculations based on data from tbe 

Depository Trust and Gearing Corporation. 
93 


76116.038

24 Monetary Policy Report to the Congress 0 July 2012 

The Capital and liquidity Position of Large U.S. Banks 

In mid-March, the Federal ReseIVe announced the 

results of the Comprehensive Capital Analysis and 

Review (CCAR) 2012. This program evaluated the 

capital planning processes and capital adequacy of 

19 of the largest banks, a subset of those that will be required to undergo annual stress~testing exer~ 

cises by the Soard of Governors underthe Dodd- Frank WaH Street Reform and Consumer Protection 

Act of 2010 (Dodd-frank Act).' These 19 bank holding companies (SHCs) also participated in the 2009 Supervisory Capital Assessment Program and 

the CCAR in 2011. The supervisory stress tests under 

CCAR 2012 evaluated whether the banks' proposed 

capital distribution plans would allow them to 

maintain sufficient capital to support lending to 

households and businesses even in the event of an 

extended period of highly adverse economic and 

1. Board of Governors of the Federal Reserve System (2012), 

Comprehensive Capitol Analysis and Review 2012: Methodology ond Results for Stress Scenario Projedions (Washington: Board 

of Governors, March 13), wwwJederalreserve,gov/newsevents 

/press/bcreglbcreg20120313atpdf. The Dodd-Frank Act requires the Board, in coordination with the appropriate pri~ 

mary financial regulatory agencies and the Federal Insurance 

Office. to conduct annual analyses of nonbank financial com- panies supervised by the Board and bank holding companies 

with total consolidated assets equal to or greater than $50 birlion to determine whether stich companie.. .. have the capital 

necessary to absorb losses that might result from a period of adverse economic conditions. AI! other financial companies 

that have total consolidated assets of more than $10 billion 

and are regulated by a primary federal financial regulatory 

agency are required to conduct annual intemal stress tests. Smaller community banks are not required to undertake stress 

tests, but any bank's primary regulator may subject the bank to 

a stress test jf conditions warrant. See Board of Governors of the Federal Reserve System, Division of Banking Supervision 

and Regulation (20l2), "'Supervisory Guidance on Stress Test~ 

ing for Banking Organizations with More Than $10 Billion in 

Total Consolidated Assets,'" Supervision and Regulation letter SR 12-7 (May 14), www.federalreserve.gov/bankinforeg! srietters/sr120Zhtm. 

from the ongoing MEP and higher-than-expected bill 

issuance by the Treasury Department earlier in the 

year. In asset-backed commercial paper (ABCP) markets, volumes outstanding declined for programs with 

European sponsors, and spreads on ABCP with European bank sponsors remained a bit above those on 

ABCP with U.S. bank sponsors. 

Respondents to the Senior Credit Officer Opinion 

Survey on Dealer Financing Terms (SCOOS) in both 

March and June indicated that credit terms applicable 

to important classes of counterparties have been relafinancial conditions. The stress scenario incorporated a peak unemployment rate of 13 percent, a 

drop in equity prices of more than 50 percent and 

a decline in house prices of 21 percent. The results 

indicated that 15 of the 19 SHCs would continue to 

meet supervisory expectations for several measures 

of capital adequacy through the end of 2013 

despite large projected losses under this extremely 

adverse hypothetical scenario, given the firms' pro~ 

posed capital distribution plans.2 

These results reflect the significant steps these 

BHCs have taken to improve their capital positions 

overthe past three years. In particular, the aggre~ 

gate Tier 1 common ratio for these 19 firms has 

doubled from about 51/2 percent in the first quarter 

of 2009 to close to 11 percent in the first quarter of 

2012 (figure A). Much of the improvement over the 

intervening period can be attributed to increased 

retained earnings and issuance of common stock 

during a period of limited growth in risk-weighted assets. 

The 19 SHCs subject to the CCAR have also reduced their vulnerabilities to disruptions in fund~ 

ing markets. For instance, they have significantly 

reduced their reliance on short-term wholesale 

liabilities relative to total assets since the height of 

2. The development of sound models is crucial to the cred~ 

ibility of any type of stress-testing exercise. As a result, the Fed~ 

eral Reserve has developed formal procedures by which 

teams of staff' members from around the federal Reserve 

System validate the supervisory models used bytne Federal Reserve during the CCAR process. furthermore, in April20l2, 

the Board announced the formation of the Model Validation 

Council, composed of outside experts, which will provide the Federal Reserve with independent advice on the processes 

used for model assessment. See Board of Governors of the 

Federal Reserve System (20l2), "Federal Reserve Board 

Announces the Formation of the Model Validation Coundl/ press release, April 20, wwwJederalreserve.gov/newsevents! 

press/bcregl20120420a.htm. 

tively stable since the beginning of the year.' In addition, dealers reported that the use of financial leverage 

among hedge funds had decreased somewhat since the 

beginning of 2012. Moreover, respondents to the June 

SCOOS noted an increase in the amount of resources 

and attention devoted to the management of concentrated exposures to dealers and other financial interme7. The SCOOS is available on the Federal Reserve Board's website 

at www:federalreserve.gov/econresdata/releasesiscoos.htm. 
94 


76116.039

A. Aggregate Tier 1 common ratio of the CCAR 

institutions. 2008-12 

----------------------------~~' 

CCAR CCAR 

SCAP 2011 2012 - 12 

10 

- g 

- 6 

2008 2009 2010 2011 2012 

NOTE: The data are quarterly and extend through 2012:Ql. For 

the defminon of Tier 1 common capital and the list of the 19 

Comprehensive Capital Analysis and Review (CCAR) institutions, 

see Board of Governors of the Federal Reserve System (2012)., 

·'Comprehen.~ive Capital Analysis and Review 2012: Methodology 

for Stress Scenario Projections," paper, Mareh 12, WWW. 

federalreserve.gov/newsevents/presslbcreglbcreg20 1203113 1.pdf. 

SCAP is the Supervisory Capital Assessment Program. 

SOURCE.: Federal Resetve Board, FR Y -9C. Consolidated 

Financial Statements for Bank Holding Companies. 

the financial crisis (figure B). In addition, these 

BHes have experienced significant inflows of relatively stable core deposits, owing in part to the 

availability of unlimited deposit insurance on 

noninterest~bearing transaction accounts from the 

Federal Deposit Insurance Corporation until the 

end of 2012, as well as the generally high demand 

for safe and liquid assets in the current 

environment. 

Overall, major U.S. financial institutions are 

much better positioned to weather an economic 

diaries as well as central counterparties and other 

financial utilities (figure 42). In response to a special 

question in the June SCOOS, dealets reported that 

despite the persistently low level of interest rates, only 

moderate fractions of their unlevered institutional clients had shown an increased appetite for credit risk or 

duration risk over the past year. 

Financial Institutions 

Market sentiment toward the banking industry fluctuated in the first half of 2012. Early in the year, after the 

Board 0/ Governors 0/ the Federal Reserve System 25 

B. Reliance on wholesale funding by CCAR 

institutions, 2008-12 

___________________________ ..::.:Percent 

- 32 

- 30 

- 28 

26 

I I I! 

2008 2009 2010 2011 2012 

NoTE.: The data are quarterly and extend through 2012:Q1. 

Reliance on wholesale funding is measured as shortAenn wholesale 

liabilities to total assets. CCAR is Comprehensive Capital Analysis 

and Review. Short-term wholesale liabilities is defined as the sum 

of large lime deposits with maturity less than one year, federal funds 

purchased and securities sold under agreements to repurchase. 

deposits in foreign offices, trading liabilities (excluding revaluation 

losses on derivatives), and other borrowed money with maturity less 

than one year. 

SOORCE: Federal Reserve Board, FR Y -9C. Consolidated 

Financial Statements for Bank Holding Companies. 

downturn while meeting the credit needs of 

potential borrowers than they were a few years 

ago, having substantially increased their capital 

buffers and improved their liquidity positions over 

the past several years. That said, a significant disruption in global financial markets, such as might 

occur if the European situation were to worsen 

markedlYI would still pose considerable challenges 

to the U.S. banking and financial systems. 

actions of the European authorities to ease the euroarea crisis and the release of the results from the 

CCAR, equity prices for bank holding companies 

(BHCs) increased and their CDS spreads declined. In 

late spring-as investors reacted to concerns about 

Europe-equity prices reversed some of those gains, 

and CDS spreads rose for large BHCs, especially those 

with substantial investment-banking operations. More 

recently, Moody's downgraded the long- and shortterm credit ratings of five of the six largest U.S. banks, 

but none of the banks lost their investment-grade status on long-term debt. The short-term debt ratings of 
95 


76116.040

26 Monetary Policy Report to the Congress 0 July 2012 

42. Net percentage of dealers reporting increased attention 

to management of exposures, 2010-12 

___________________________________ P~~m 

80 

To other dealers 60 

40 

20 

NOTE: The data are drawn from a survey coRducted four times per year; 

the last observation is from the june 2012 survey. which covers 20l2:Q2. Net 

percentage equals the percentage of institutions that reported increasing 

attention ("increased considerably" or "increased somewhat") minus the 

percentage of institutions that reported decreasing attention ("decreased 

considerably" or "decreased somewhat"), 

SOURCE: Federal Reserve Board. Senior Credit Officer Opinion Survey on 

Dealer Financing Terms. 

some banks were downgraded to Prime-2, which may 

affect the ability of some to place significant amounts 

of CP with money market funds, but the market effect 

appears to have been muted so far, as those banks currently have limited demand for such funding. On balance, equity prices of banks rose significantly from 

relatively low levels at the start of the year (figure 43); 

an index of CDS spreads for large BHCs declined 

about 60 basis points but remained at a high level 

(figure 44). 

43. Equity price index for banks, 2009-12 

January 2. 2009 "" 100 

120 

110 

100 

90 

80 

70 

60 

44. Spreads on credit default swaps for selected 

U.S. banldng organizations, 2007-12 

________________________________ .~ ___ ·s points 

July Jan. July Jan. July Jan. July Jan. July 

2009 2010 2011 2012 

400 

350 

300 

250 

200 

150 

100 

50 

NOTE: The data are daily and extend through July 13, 2012. Mediar 

spreads for six large bank holding companies and nine other banks. 

SOURCE: Markit. 

The profitability of BHCs decreased slightly in the 

first quarter of 2012 and remained well below the levels 

that prevailed before the financial crisis (figure 45). 

Litigation provisions taken by some large banks in 

connection with the mortgage settlement reached earlier this year accounted for some of the downward 

pressure on bank profitability. The variability in earnings due to accounting gains and losses related to 

changes in the market value of banks' own debt amplified recent swings of bank profits.' Smoothing through 

8, Under fair value accounting rules, changes in the creditworthi~ 

ness of a BHe generate changes in the value of some of its liabilities. 

Those changes are then reflected as gains or losses on the income 

statement 

45. Profitability of bank holding companies, 1997-2012 

Percen!. annual rate Perccnt.annuairale 

Rerum on assets 1.5 

1.0 

.5-

+ 

o ------------------~~~-----

.5 

20 

10 

+ 

o 

10 

50 1.0 

I .I.t ,j ,f. ! ,I,! !! Jan. July Jan. July Jan. Ju1y 

2009 2010 2011 2012 

N()TE: The data are daily and extend through July 13.2012. 

SOURCE: Standard & Poor's. 

40 

30 1.5 20 

! ! I I ! ! ! I I I I I ! ! I ! 

2000 2004 2008 2012 

Narn: The data are quarterly and extend through 20l2:QL 

SOURCE: Federal Reserve Board, FR Y ~9C, Consolidated Financial 

Statements for Bank HQlding Companies. 
96 


76116.041

these special factors, profitability has been about flat in 

recent quarters. Net income continued to be supported 

by the release of loan loss reserves, albeit to a lesser 

extent than in the previous year, as charge-off rates 

decreased a bit further across most major asset classes. 

Still-subdued dividend payouts and share repurchases 

as well as reductions in risk-weighted assets pushed 

regulatory capital ratios higher in the first quarter of 

2012 (see the box "Implementing the New Financial 

Regulatory Regime"). 

Credit provided by commercial banking organizations in the United States increased in the first half of 

2012 at about the same moderate pace as in the second 

half of 2011. Core loans-the sum of C&I loans, real 

estate loans, and consumer loans-expanded modestly; 

as noted earlier, the upturn in lending was particularly 

noticeable for C&I loans (figure 46). The expansion in 

C&I lending has been broad based outside of U.S. 

branches and agencies of European banks and has 

been particularly evident at large domestic banks. This 

pattern is consistent with SLOOS results suggesting 

that a portion of the increase in C&I lending observed 

at large domestic banks reflected decreased competition from European banks and their affiliates and subsidiaries for either foreign or domestic customers. 

Banks' holdings of securities rose moderately, with 

purchases concentrated in Treasury securities and 

agency-guaranteed MBS. Given the still-depressed 

housing market, banks continued to be attracted by 

46. Change in commercial and industrial loans and core 1oans. 

1990-2012 

Peroent,anlllJalral:e 

I I I ! I I ! ! ! ! I ! ! ! ! !! ! I I J I !! ! I 

1992 1996 2000 2004 2008 2012 

30 

20 

10 

+ 

o 

10 

20 

30 

NOTE: The data, which are seasonally adjusted, are quarterly and extend 

through 2012:Q2. Core loans consist of commercial and industrial loans, real 

estate loans, and consumer loans. Data have been adjusted for banks' 

implementation of certain accounting rule changes (including the Financial 

Accounting Standards Board's Statements of Financial Accounting Standards 

Nos. 166 and 167) and for the effect." of large nonbank institutions converting 

to conunercial banks or merging with a commercial bank. 

SOURCE: Federal Reserve Board. Statistical Release H.g, "Assets and 

Liabilities of Commercial Banks in the United States." 

Board of Governors of the Federal Reserve System 27 

the government guarantee on agency securities, and 

some large banks may also have been accumulating 

government-backed securities to improve their liquidity positions. 

Corporate Debt and Equity Markets 

Yields on investment-grade bonds reached record lows 

in June, partly reflecting the search by investors for 

relatively safe assets in light of rising concerns about 

Europe as well as the weakness in the domestic and 

global economic data releases. However, yields on 

speculative-grade corporate debt, which had reached 

record-low levels in February, rose somewhat in the 

second quarter reflecting those same concerns. The 

spread on investment-grade corporate bonds was 

about unchanged, on net, relative to tbe start of the 

year. Despite the backup in yields over the second 

quarter, spreads on speculative-grade corporate bonds 

decreased some, on balance, over the same period (figure 47). Prices in tbe secondary market for syndicated 

leveraged loans have changed little, on balance, since 

the beginning of tbe year; demand from institutional 

investors for these mostly floating-rate loans has 

remained strong despite the reemergence of anxiety 

about developments in Europe (figure 48). 

Broad equity price indexes were boosted early in the 

year by improved sentiment stemming in part from 

relatively strong job gains as well as actions taken by 

major central banks to mitigate the financial strains 

47. Spreads of corporate bond yields over comparable 

off-the-run Treasury yields. by securities rating, 

1997-2012 

Percentage points 

I ! ! ! ! ! ! I ! ! I I ! ! I j ! I I 

1998 2000 2002 2004 2006 2008 2010 2012 

NOTE: The data are daily and extend through July 13, 2012. The spreads 

shown are the yields on 10-year bonds less the 10-yearTreasury yield. 

SOURCE: Derived from smoothed corporate yield curves using Merrill 

Lynch bond data. 
97 


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28 Monetary Policy Report to the Congress 0 July 2012 

Implementing the New Financial Regulatory Regime 

The Board of Governors is involved in approximately 250 initiatives-including rulemakings, associated guidance, studies of various financial issues, 

and design of internal processes-related to the 

Dodd-Frank Wall Street Refonn and Consumer 

Protection Act of 2010 (Dodd-Frank Act). The 

Board is the lead agency responsible for implementing a significant number of rulemakings 

required under the act and is also; on many of 

these initiatives, working in conjunction with other 

federal agencies. For example, as a member of the 

Financial Stability Oversight Council (FSOC), the 

Board has contributed to FSOC studies mandated 

by the act and has assisted the fSOC with proposed and final rulemakings. 

A number of the rulemakings are directed at 

enhancing bank supervision and prudential standards. In one recent action, the Board and the 

other federal bank regulatory agencies issued a 

final rule on June 7, 2012, that implements changes 

to the market risk capital rule. These changes bring 

it into conformance with international standards 

and replace agency credit ratings with alternative 

standards of creditworthiness in accordance with 

the requirements of section 939A of the DoddFrank Act.1 In addition, "living wills" were prepared 

by bank holding companies with assets of $50 billion or more based on a final rule issued in Octo1. Board of Governors of the Federal Reserve System (2012), uFederal Reserve Board Approves Final Rule to Implement 

Changes to Market Risk Capital Rute/ press release, June 7, 

www.federalreserve.gov/newsevents/press/bcregl 

20120607b.htm. 

emanating from Europe. However, equity price indexes 

subsequently reversed a portion of their earlier gains 

as concerns about the European banking and fiscal 

crisis intensified again and economic reports suggested 

slower growth, On balance, at home and abroad (figure 49). The spread between the 12-month forward 

earnings-price ratio for the S&P 500 and a real longrun Treasury yield-a rough gauge of the equity risk 

premium-widened a bit more in the first half of 2012, 

and is now closer to the very high levels it reached in 

2008 and again last fall (fignre 50). Implied volatility 

for the S&P 500 index, as calculated from option 

prices, spiked at times this year but is currently toward 

ber 2011.2 On June 29, 2012, the Board and the 

Federal Deposit Insurance Corporation announced 

the process they wilt use to review, during the second half of 2012, the first set of these plans from 

some of the largest internationally active banking 

organizations.3 

Also, several key notices of proposed rulemakings (NPRs) implementing the Dodd-Frank Act 

have been issued thus far in 2012. In particuJar, on 

June 7, 2012, the Board issued for comment three 

proposed rules that, taken together, integrate the 

capital provisions of section 171 of the act with 

those of Basel III capital standards in order to 

enhance financial stability while minimizingthe 

burden on affected institutions.4 

2. Board of Govemors of the Federal Reserve System (2011), "Federal Reserve Board Approves Final Rule Implementing the 

Resolution plan Requirement of the Dodd-Frank Act," press 

release, October 17, www.federalreserve.gov/newsevents/ 

press/bcreg/201l1017a.ntm. 

3. Board of Governors of the Federal Reserve System and 

Federal Deposit Insurance Corporation (2012), ~Federal 

Reserve Board and Federal Deposit Insurance Corporation 

Announce Process for Receiving and Evaluating Initial Resolution Plans, Also Known as living WiUs,w joint press release, 

June 29, www.federalreserve.gov!newsevents/press/bcreg! 20120629b.htm. 

4. With the encouragement and support of the U.S. bank regulato')' agencies, the Basel Committee on Banking Supervision has strengthened global capital requirements: raising risk 

weightings for traded assets, improving the quality of Jossabsorbing capital through a new minimum common equity 

ratio standard, creating a capital conservation buffer, and introdUcing an international leverage ratio requirement. See Basel Committee on Banking Supervision (20l0), Basel Ill: A 

Global Regulatory Framework for More Resilient Bonks and 

Bonking Systems (Basel, Switzerland: Bank for International 

the bottom end of the range that this indicator has 

occupied since the onset of the financial crisis (figure 51). 

In the current environment of very low interest rates, 

mutual funds that invest in higher-yielding debt instruments (inclnding speculative-grade corporate bonds 

and leveraged loans) continued to have significant 

inflows for most of the first half of 2012, while money 

market funds experienced outflows (fignre 52). Equity 

mutual funds also recorded modest outflows early in 

the year and, as market sentiment deteriorated, both 

equity and high-yield mutual funds registered outflows 

in May. 
98 


76116.043

The first NPR would increase the quantity and 

quality of capital by, in part, requiring a new minimum common equity Tier 1 ratio of 4,5 percent, 

instituting a common equity Tier 1 capital conservation buffer of 2.5 percent, and raising the minimum 

for the broader Tier 1 capital ratio from 4 percent to 

6 percentS The NPR does not addressspecific 

Basel III liquidity standards, which have not been 

finalized by the Basel Committee on Banking 

Supervision.6 

The second NPR revises certain aspects of the 

risk-based capital requirements in orderto 

enhance risk sensitivity and address weaknesses in 

the calculation of risk-weighted assets that have 

been identified over the past several years. The 

third NPR requires internationally active banks to 

improve the risk sensitivity of parts of their current 

advanced approaches to risk-based capital processes to better address counterparty credit risk 

and interconnectedness among financial 

institutions. 

Several other actions taken with regard to the 

Dodd-Frank Act provided additional clarity to pro-

~ttlements, December; rev. June 20m, www.bis.orglpublj 

bcbs189.htm. 

5. The Tied capital ratio is the ratio of Tier 1 capital to riskweighted assets. Tierl capital consists primarily of common 

equity (excluding intangible assets such as goodwill and 

excluding net unrealized gains on investment account securities classified as available for sale) and certain perpetual preferred stock. 

6. Basel Committee on Banking Supervision (2010), Base! III: 

fnternationalFramework for liqUidity RiskMeasurement, 

Standards and Monitoring (Basel, Switzerland: Bank for 

Intemational Settlements, December), www.bis.org/pubV 

bcbslB8.htm. 

Monetary Aggregates and the Federal 

Reserve's Balance Sheet 

The growth rate of M2 slowed in the first half of 2012 

to an annual rate of about 7 percent (figure 53)? How9. M2 consists of (1) currency outside the US. Treasury, Federal 

Reserve Banks. and the vaults of depository institutions; (2) traveler's 

checks of nonbank issuers; (3) demand deposits at commercial banks 

(excluding those amounts held by depository institutions, the u.s. government, and foreign hanks and official institutions) less cash 

items in the process of collection and Federal Reserve float; (4) other 

checkable deposits (negotiable order of withdrawal, or NOW, 

accounts and automatic transfer service accounts at depository institutions; credit union share draft accounts; and demand deposits at 

thrift institutions); (5) savings deposits (induding money market 

deposit accounts); (6) small-denomination time deposits (time depos~ 

its issued in amounts of less than $100,000) less individual retirement 

Board of Governors of the Federal Reserve System 29 

posed rulemakings. For example, on April 2, 2012, 

the Board published an amendment to a proposed 

rulemaking clarifYing the activities that are deemed 

to be financial for purposes of title I of the DoddFrank Act. This rulemaking is designed to provide 

clarity regarding firms that may be designated for 

enhanced supelVision by the FSOC? In addition, 

the Board, along with other regulatory agencies, is 

reviewing about 19,000 comment letters on the 

proposal to implement section 619 of the act, commonly known as the Voleker rule. The rule generally prohibits banking entities from engaging in 

proprietary trading or acquiring an ownership interest in, sponsoring, or having certain other relationships with a hedge fund or private equity fund. On 

April 19, the Board issued a clarification regarding 

the Volcker rule confonnance period, stating that a 

banking entity has the full two-year period provided by statute (that is, until July 21,2014), unless 

extended by the Board, to fully conform its activities and investments to the requirements of the 

Voleker ruleS 

Z Under title 1 of the Dodd-frank Act,. a company generally 

can be designated for Board supervision by the FSOC only if 

85 percent or more of the company's revenues or assets are 

related to activities that are financial in nature under the Bank 

Holding Company Act. 

B. Board of Governors of the Federal Reserve System, COf'fr 

modity Futures Trading Commission. Federal Deposit Insur- ance Corporation. Office of the Comptroller of the Currency, 

and Securities and Exchange Commission (2012), "Vokker 

Rule Conformance Period Clarified," joint press release, 

April 19, WYM.federalreserve.gov/newsevents/press/bcregi 

20120419a.htm. 

ever, the levels of M2 and its largest component, liquid 

deposits, remain elevated relative to what would have 

been expected based on historical relationships with 

nominal income and interest rates, likely reflecting 

investors' continued preference to hold safe and liquid 

assets. Currency in circulation increased robustly, 

reflecting solid demand both at home and abroad. 

Retail money market funds and small time deposits 

continued to contract. At the same time as currency in 

circulation was increasing, reserve balances held at the 

Federal Reserve were decreasing; as a result, the monetary base-which is equal to the sum of these two 

account (IRA) and Keogh balances at depository institutions; and (7) 

balances in retail money market mutual funds less IRA and Keogh 

balances at money market mutual funds. 
99 


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30 Monetary Policy Report to the Congress 0 July 2012 

48. Secondary-market bid prices for syndicated Joans, 

2007-12 

100 

90 

80 

70 

60 

50 

items--changed little, on average, over the first half of 

the year. 

Total assets of the Federal Reserve decreased to 

$2,868 billion as of July II, 2012, about $60 billiou less 

than at the end of 2011 (table I). The small decrease 

since December largely refiects lower usage of foreign 

central bank liquidity swaps and declines in the net 

portfolio holdings of the Maiden Lane LLCs. The 

composition of Treasury security holdings changed 

over the Course of the first half of this year as a result 

of the implementation of the MEl'. As of July 13, 

2012, the Open Market Desk at the Federal Reserve 

Bank of New York (FRBNY) had purchased $283 billion in Treasury securities with remaining maturities of 

49. Stock price index, 1995-2012 

January 3,200500 100 

Dow Jones total stock market index 140 

120 

loo 

80 

60 

40 

50. Real and 12-month forward 

S&P 500,1995-2012 

Percent 

--------------------------- 12 

6 to 30 years and sold or redeemed $293 billion in 

Treasury securities with maturities of 3 years or less 

under the MEP. 1O Total Federal Reserve holdings of 

agency MBS increased about $18 billion as the policy 

of reinvesting principal payments from agency debt 

and agency MBS into agency MBS continued. 

In the first half of 2012, the Federal Reserve continued 10 reduce its exposure to facilities established dur10, Between the MEP's announcement in September 2011 and the 

end of that year, the Desk had purchased $133 billion inlonger~term 

Treasury securities and had sold $134 billion in shorter~term Treasury securities. 

51. Implied S&P 500 volatility, 1995-2012 

-------------'-"""'"' 
100 


76116.045
101 


76116.046

32 Monetary Policy Report to the Congress 0 July 2012 

in January and February enabled the repayment of the 

entire remaining outstanding balance of the senior 

loan from the FRBNY to Maiden Laue II LLC in 

March, with interest and a $2.8 billion net gain. In 

addition, proceeds from the sales of assets from 

Maiden Lane LLC and Maiden Lane III LLC in April 

and May enabled the repayment, with interest, of the 

entire remaining outstanding balances of the senior 

loans from the FRBNY to Maiden Lane LLC and 

Maiden Lane III LLC in June. Proceeds from further 

asset sales from Maiden Lane III in June enabled 

repayment of the equity position of AIG in July. A net 

gain on the sale of the remaining assets in Maiden 

Lane III LLC is likely during the next few months. 

Sales of most of the remaining assets in Maiden Lane 

LLC should be completed by the end of the year, but a 

few legacy assets may take longer to dispose of. Loans 

outstanding under the Term Asset-Backed Securities 

Loan Facility (TALF) were slightly lower, reflecting, in 

part, the first maturity of a TALF loan with a threeyear initial term. 

On the liability side of the Federal Reserve's balance 

sheet, deposits held by depository institutions declined 

about $42 billion in the first half of 2012, while Federal 

Reserve notes in circulation increased roughly $39 billion. As part of its ongoing program to ensure the 

readiness of tools to drain reserves when doing so 

becomes appropriate, the Federal Reserve conducted a 

series of small-scale reverse repurchase transactions 

involving all eligible collateral types with its expanded 

list of counterparties. In the same vein, the Federal 

Reserve also continued to offer small-value term deposits through the Term Deposit Facility. 

On March 20, the Federal Reserve System released 

its 2011 combined annual comparative audited financial statements. The Federal Reserve reported net 

income of about $77 billion for the year ending 

December 31, 2011, derived primarily from interest 

income on securities acquired through open market 

operations (Treasury securities, federal agency and 

GSE MBS, and GSE debt securities). The Reserve 

Banks transferred about $75 billion of the $77 billion 

in comprehensive income to the U.S. Treasury in 2011; 

though down slightly from 20 II, the transfer to the 

U.S. Treasury remained historically very large. 

International Developments 

The European fiscal and banking crisis continued to 

affect international financial markets and foreign economic activity during the first half of 2012. Early in 

the year, aggressive action by the ECB and some progress in addressing the crisis by the region's leaders contributed to a temporary easing of financial stresses. 

(See the box" An Update on the European Fiscal and 

Banking Crisis.") However, amid ongoing political 

uncertainty in Greece and increased concerns about 

the health of Spanish banks, financial conditions deteriorated again in the spring. Foreign economic growth 

picked up in the first quarter, but this acceleration 

largely reflected temporary factors, and recent data 

point to widespread slowing in the second quarter. 

International Financial Markets 

Foreign financial markets have been volatile. Initially in 

the first quarter, encouraging macroeconomic data and 

some easing of tensions within the euro area led to an 

improvement in global financial conditions. This 

improvement was reversed in the spring as the boost 

from previous policy measures, including the ECB's 

longer-term refinancing operations, faded and political 

and banking stresses in vulnerable European countries 

resurfaced. Euro-area leaders responded to the worsening of the crisis by announcing additional measures at 

a summit on June 28-29. The market reaction was 

positive but short-lived. 

Increased uncertainty and greater volatility have 

pushed up the foreign exchange value of the dollar 

about 4\4 percent on a trade-weighted basis against a 

broad set of currencies since its low in early February, 

with most of the appreciation occurring in May (figure 54). Typical of periods of flight to safety, the dollar 

has appreciated against most currencies but depreciated against the Japanese yen for most of the period 

(fignre 55). The Swiss franc has moved very closely 

with the euro as the Swiss National Bank has intervened to maintain a ceiling for the franc relative to the 

euro. 

During the second quarter of this year, flight-tosafety flows and the deteriorating global economic outlook helped push government bond yields for Canada, 

Germany, and the United Kingdom to record lows 

(figure 56). Likewise, Japanese yields on IO-year bonds 

fell well below I percent. By contrast, Spanish sovereign spreads over German bnnds rose more than 

250 basis points between February and June due to 

escalating concerns over Spain's public finances (figure 57). Italian sovereign spreads moved up as well 

over this period. 

Equity prices abroad declined significantly in the 

second quarter, more so than in the United States. 

Indexes tumbled in the nations at the center of the 

euro-area fiscal and banking crisis, and the fall in value 
102 


76116.047

11\) 
103 


76116.048

34 Monetary Policy Report to the Congress 0 July 2012 

---------------------------

58. 

An on the !::UHJU""''' fiscal and Ib.n~"Ir • .,.Crisis 

months, the crisis in Europe 

and waned as stresses related to fjnanc~ 

condition of banking sectors 

contributed to a marked improvement in financial 

indexes in selected advanced foreign economies, 

lune 30, 2009 "" 100 

ISD 

59. 

SOl..'RCE: Bloomberg. 

for emerging m.arket 
104 


76116.049

11M nil h:& ;& II 
105 


76116.050
106 


76116.051

Extended Collateral Term Repo facility, offering sixmonth funds against a wide set of collateral. In addition, in July, the BOE increased the size of its asset 

purchase program from £325 billion to £375 billion, 

and, together with the UK. Treasury, introduced a 

new Funding for Lending Scheme designed to boost 

lending to households and firms. 

Emerging Market Economies 

Following a disappointing performance at the end of 

last year, real GOP growth rebounded in the first quarter in most EMEs. Economic activity expanded especially briskly in emerging Asia, largely reflecting the 

reconnection of supply chains damaged by the floods 

in Thailand. Economic growth, however, continued to 

slow in China and India. Moreover, recent indicators 

suggest that the pace of economic activity decelerated 

in most EMEs going into the second quarter amid 

headwinds associated with the European crisis and 

relatively subdued growth in China. 

In China, real GOP increased at about a 7 percent 

pace in the first half of the year, down from an 81> percent pace in the second half of last year. The slowdown 

reflected weaker demand for Chinese exports as well as 

domestic factors, including moderating consnmer 

spending and the restraining effects on investment of 

previous govenunent measures to cool activity in the 

property sector. Macroeconomic data for May and 

June suggest that economic activity was picking up a 

bit toward the end of the second quarter, with growth 

of investment, retail sales, and bank lending edging 

higher. Headline 12-month inflation fell to 2.2 percent 

in June, led by additional moderation in food prices. 

As inflationary pressures eased and concerns about 

growth mounted, the People's Bank of China lowered 

banks' reserve requirements by 50 basis points in both 

February and May and then reduced the benchmark 

Board of Governors of the Federal Reserve System 37 

one-year lending rate by 25 basis points in June and 

31 basis points in July, the first changes in that rate 

since an increase in July of last year. Over the first half 

of the year, the renminbi was little changed, on net, 

against the dollar, but it appreciated about II> percent 

on a real trade-weighted basis, as the renminbi followed the dollar upward against China's other major 

trading partners. 

In India, economic growth has also moderated as 

slow progress on fiscal and structural reforms and previous monetary tightening stalled investment. Noting 

rising vulnerabilities from the country's twin fiscal and 

current account deficits, some credit rating agencies 

warned that India's sovereign debt risks losing its 

investment-grade status. 

In Mexico, economic activity rebounded briskly in 

the first quarter as the agricultural sector rebounded 

from the fonrth-quarter drought, domestic demand 

gained momentnm, and exports to the United States 

picked up. Economic indicators, however, suggest that 

growth moderated somewhat in the second quarter. On 

July I, Enrique Peiia Nieto of the Institutional Revolutionary Party, or PRI, won the Mexican presidential 

election, promising to pursue market-oriented reforms 

to bolster economic growth. 

In Brazil, real GOP-restrained by flagging investment and weather-related problems in the agricultural 

sector-increased slightly in the first quarter, making it 

the fourth consecutive quarter of below-trend growth. 

Industrial production, which has been on a downward 

trend since early 20 II, continued to fall through May, 

suggesting that economic activity in Brazil remained 

weak in the second quarter. 

Headline inflation generally moderated in the EMEs 

reflecting lower food price pressures and weaker economic growth. In addition to China, several other central banks in the EMEs also loosened monetary policy, 

including those in Brazil, Chile, India, Indonesia, the 

Philippines, South Korea, and Thailand. 
107 


76116.052

j :: 
108 


76116.053

40 Monetary Policy Report to the Congress 0 July 2012 

Nonetheless, participants expected that global financial 

markets would remain focused on the evolving situation in Europe, and they anticipated that further policy 

efforts would be required to fully address the fiscal and 

financial problems there. 

With the economy facing continuing headwinds and 

growth slowing in several U.S. export markets, members generally expected a modest pace of economic 

growth over coming quarters, with the unemployment 

rate declining only gradually. At the same time, members thought that inflation would run at levels at or 

below those consistent with the Committee's dual 

mandate. Against this backdrop, members agreed to 

keep the target range for the federal funds rate at 0 to 

Y. percent, to continue the program of extending the 

average maturity of the Federal Reserve's holdings of 

securities as announced in September, and to retain the 

existing policies regarding the reinvestment of principal payments from Federal Reserve holdings of securities. In light of the economic outlook, most members 

also agreed to indicate that the Committee anticipates 

that economic conditions are likely to warrant exceptionally low levels for the federal funds rate at least 

through late 2014, longer than had been indicated in 

recent FOMC statements. The Committee also stated 

that it is prepared to adjust the size and composition of 

its securities holdings as appropriate to promote a 

stronger economic recovery in a context of price 

stability. 

The data in hand at the March 13 FOMC meeting 

indicated that U.S. economic activity had continued to 

expand moderately. Although the unemployment rate 

remained elevated, it had declined notably in recent 

months and payroll employment had increased. 

Household spending and business fixed investment had 

advanced. Signs of improvement or stabilization 

emerged in some local housing markets, but overall 

housing activity continued to be restrained by the substantial inventory of foreclosed and distressed properties, tight credit conditions for mortgage loans, and 

uncertainty about the economic outlook and future 

home prices. Inflation continued to be subdued, 

although prices of crude oil and gasoline had increased 

substantially. Longer-term inflation expectations had 

remained stable. 

Many participants believed that policy actions in the 

euro area, notably the Greek debt swap and the ECB's 

longer-term refinancing operations, had helped ease 

strains in financial markets and reduced the downside 

risks to the U.S. and global economic outlook. Against 

that backdrop, equity prices had risen and conditions 

in credit markets improved, leading many meeting participants to see financial conditions as more supportive 

of economic growth than at the time of the January 

meeting. 

Members viewed the information on U.S. economic 

activity as suggesting that the economy would continue 

to expand moderately. However, despite the easing of 

strains in global financial markets, members continued 

to perceive significant downside risks to economic 

activity. Members generally anticipated that the recent 

increase in oil and gasoline prices would push up inflation temporarily, but that inflation subsequently would 

run at or below the rate that the Committee judges 

most consistent with its mandate. As a result, the 

Committee decided to keep the target range for the 

federal funds rate at 0 to Y. percent, to reiterate its 

anticipation that economic conditions were likely to 

warrant exceptionally low levels for the federal funds 

rate at least through late 2014, to continue the program 

of extending the average maturity of the Federal 

Reserve's holdings of securities that it had adopted in 

September, and to maintain the existing policies 

regarding the reinvestment of principal payments from 

Federal Reserve holdings of securities. The Committee 

again stated that it is prepared to adjust the size and 

composition of its securities holdings as appropriate to 

promote a stronger economic recovery in a context of 

price stability. 

By the time of the April 24-25 FOMC meeting, the 

data again indicated that economic activity was 

expanding moderately. Payroll employment had continued to move up, and the unemployment rate, while 

still elevated, had declined a little further. Household 

spending and business fixed investment had continued 

to expand. The housing sector showed signs of 

improvement but from a very low level of activity. 

Mainly reflecting the increase in the prices of crude oil 

and gasoline earlier this year. inflation had picked up 

somewhat; however, measures of long.run inflation 

expectations remained stable. Meeting participants 

judged that, in general, conditions in domestic credit 

markets had improved further, but noted that investors' concerns about the sovereign debt and banking 

situation in the euro area intensified during the intermeeting period. Many U.S. financial institutions had 

been taking steps to bolster their resilience, including 

expanding their capital levels and liquidity buffers and 

reducing their European exposures. 

Members expected growth to be moderate over coming quarters and then to pick up over time. Strains in 

global financial markets stemming from the sovereign 

debt and banking situation in Europe as well as uncertainty about U.S. fiscal policy continued to pose significant downside risks to economic activity both here 

and abroad. Most members anticipated that the 
109 


76116.054

increase in inflation would prove temporary and that 

subsequently inflation would run at or below the rate 

that the Committee judges to be most consistent with 

its mandate. Against this backdrop, the Committee 

members reached the collective judgment that it would 

be appropriate to maintain the existing highly accommodative stance of monetary policy. In particular, the 

Committee agreed to keep the target range for the federal funds rate at 0 to \4 percent, to continue the program of extending the average maturity of the Federal 

Reserve's holdings of securities as announced last September, and to retain the existing policies regarding the 

reinvestment of principal payments from Federal 

Reserve holdings of seenrities. The Committee left the 

forward guidance for the target federal funds rate 

unchanged at this meeting. Members emphasized that 

their forward guidance was conditional on expected 

economic developments, but they preferred adjusting 

the forward guidance only once they were more confident that the medium-term economic outlook or the 

risks to that outlook had changed Significantly. 

Data received over the period leading up to the June 

19-20 FOMC meeting indicated that economic activity 

was expanding at a somewhat more modest pace than 

earlier in the year. Improvements in labor market conditions had slowed in recent months, and the unemployment rate seemed to have flattened out. Household 

spending appeared to be rising at a somewhat slower 

rate, and business investment had continued to 

advance. Despite some ongoing signs of improvement, 

the housing sector remained depressed. Consumer 

price inflation had declined, mainly reflecting lower 

prices of crude oil and gasoline, and longer-term inflation expectations remained well anchored. Meeting 

participants observed that financial markets were volatile over the intermeeting period and that investor sentiment was strongly influenced by the developments in 

Europe and evidence of slowing economic growth at 

home and abroad. 

In the discussion of monetary policy, most members 

agreed that the outlook had deteriorated somewhat 

relative to the time of the April meeting, and that significant downside risks were present, importantly 

including the financial stresses in the euro area and 

uncertainty about the degree of fiscal restraint in the 

United States, and its effects on economic activity over 

the mediunl term. As a result, the Committee decided 

that providing additional monetary policy accommodation would be appropriate to support a stronger economic recovery and to help ensure that inflation, over 

time, was at a level consistent with the Committee's 

dual mandate. Specifically, the Committee agreed to 

continue the MEP through the end of the year, instead 

Board of Governors of the Federal Reserve System 41 

of ending the program in June as had been planned. In 

doing so, the Federal Reserve will purchase Treasury 

securities with remaining maturities of 6 years to 

30 years and sell or redeem an equal par value of 

Treasury securities with remaining maturities of 

approximately 3 years or less. This continuation of the 

MEP will proceed at about the same pace as had been 

executed through the Iirst phase of the program, 

increasing the Federal Reserve's holdings of longerterm Treasury securities by about $267 billion while 

reducing its holdings of shorter-term Treasury securities by the same amount. For the duration of this program, the Committee directed the Open Market Desk 

to suspend its current policy of rolling over maturing 

Treasury securities into new issues at auction (and 

instead purchase only additional longer-term securities 

with the proceeds of maturing securities). The Committee expected the continuation of the MEP to put 

downward pressure on longer-term interest rates and 

help make broader financial conditions more accommodative. In addition, the Committee decided to continue reinvesting principal payments from its holdings 

of agency debt and agency MBS in agency MBS. The 

Committee also decided to keep the target range for 

the federal funds rate at 0 to \4 percent and to reaffirm 

its anticipation that economic conditions were likely to 

warrant exceptionally low levels for the federal funds 

rate at least through late 2014. In its statement, the 

Committee noted that it was prepared to take further 

action as appropriate to promote stronger economic 

recovery and sustained improvement in labor market 

conditions in a context of price stability. 

FOMC Communications 

Transparency is an essential principle of modern central banking because it contributes to the accountability of central banks to the government and to the public and because it can enhance the effectiveness of 

central banks in achieving their macroeconomic objectives. To this end, the Federal Reserve provides to the 

public a considerable amount of information concerning the conduct of monetary policy. Following each 

meeting of the FOMC, the Committee inunediately 

releases a statement that lays out the rationale for its 

policy decision and issues detailed minutes of the 

meeting about three weeks later. Lightly edited transcripts of FOMC meetings are released to the public 

with a five-year lag. l2 Moreover, beginning in April 

12. FOMC statements, minutes, and transcripts, as well as other 

related information, are available on the Federal Reserve Board's 

website at www.federalreserve.gov!monetarypolicylfomc.htm. 
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42 Monetary Policy Report to the Congress 0 July 2012 

2011, the Chairman has held press conferences on an 

approximately quarterly basis. At the press conferences, the Chairman presents the current economic 

projections of FOMC participants and provides additional context for the Committee's policy decisions. 

The Committee continued to consider further 

improvements in its communications approach in the 

first half of 2012. At the January meeting, the FOMC 

released a statement of its longer-ruu goals and policy 

strategy in an effort to enhance the transparency, 

accountability, and effectiveness of monetary policy 

and to facilitate well-informed tlecisionmaking by 

households and bnsinesses.!3 The statement did not 

represent a change in the Committee's policy 

approach, but rather was intended to help enhance the 

transparency, accountability, and effectiveness of monetary policy. The statement emphasizes the Federal 

Reserve's firm commitment to pursue its congressional 

mandate to promote maximum employment, stable 

prices, and moderate long-term interest rates. To 

clarify its longer-term objectives, the FOMC stated 

that inflation at the rate of 2 percent, as measured by 

the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve's statutory mandate. 

While noting that the Committee's assessments of the 

maximum level of employment are necessarily uncertain and subject to revision, the statement indicated 

that the central tendency of FOMC participants' current estimates of the longer-run normal rate of unemployment is between 5.2 and 6.0 percent. It stressed 

that the Federal Reserve's statutory objectives are generally complementary, but when they are not, the Committee will follow a balanced approach in its efforts to 

return both inllation and employment to levels consistent with its mandate. 

In addition, in light of a decision made at the 

December meeting, the Committee provided, starting 

in the January Summary of Economic Projections 

(SEPl, information about each participant's assessment of appropriate monetary policy. Specifically, the 

SEP included information about participants' estimates of the appropriate level of the target federal 

funds rate in the fourth quarter of the current year and 

the next few calendar years, and over the longer run; 

the SEP also reported participants' current projections 

of the likely timing of the appropriate first increase in 

the target federal funds rate given their assessments of 

the economic outlook. The accompanying narrative 

13. The FOMe statement of longer-run goals and policy strategy 

is available on the Federal Reserve Board's website at 

www.federalreserve.gov/monetarypolicy/fomccalendars.htm. 

described the key factors underlying those assessments 

and provided some qualitative information regarding 

participants' expectations for the Federal Reserve's 

balance sheet. 

At the March meeting, participants discussed a 

range of additional steps that the Committee might 

take to help the public better understand the linkages 

between the evolving economic outlook and the Federal Reserve's monetary policy decisions, and thus the 

conditionality in the Committee's forward guidance. 

Participants discussed ways in which the Committee 

might include, in its postmeeting statements and other 

communications, additional qualitative or quantitative 

information that could convey a sense of how the 

Committee might adjust policy in response to changes 

in the economic outlook. However, partiCipants also 

observed that the Committee had introduced several 

important enhancements to its policy communications 

over the past year or so; these included the Chairman's 

postmeeting press conference as well as changes to the 

FOMC statement and the SEP. Against this backdrop, 

some participants noted that additional experience 

with the changes implemented to date could be helpful 

in evaluating potential further enhancements. 

At the April meeting, the Committee discussed the 

relationship between the postmeeting statement, which 

expresses the collective view of the Committee, and the 

policy projections of individual participants, which are 

included in the SEP. The Chairman asked the subcommittee on communications to consider possible 

enhancements and refinements to the SEP that might 

help clarify the link between economic developments 

and the Committee's view of the appropriate stance of 

monetary policy. Following up on this issue at the June 

meeting, participants discussed several possibilities for 

enhancing the clarity and transparency of the Committee's economic projections as well as the role they 

play in policy decisions and policy communications. 

Many participants indicated that if it were possible to 

construct a quantitative economic projection and associated path of appropriate policy that reflected the collective judgment of the Committee, such a projection 

could potentially be helpful in clarifying how the outlook and policy decisions are related. However, many 

participants noted that developing a quantitative forecast that rellects the Committee's collective judgment 

could be challenging, given the range of their views 

about the economy's structure and dynamics. Participants agreed to continue to explore ways to increase 

clarity and transparency in the Committee's policy 

communications, but many emphasized that further 

changes in those communications should be considered carefully. 
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43 

Part 4 

Summary of Economic Projections 

The following material appeared as an addendum to the 

minutes of the June /9-20, 2012, meeting of the Federal 

Open Market Committee. 

In conjunction with the June 19-20,2012, Federal 

Open Market Committee (FOMC) meeting, meeting 

participants-the 7 members of the Board of Governors and the 12 presidents of the Federal Reserve 

Banks, all of whom participate in the deliberations of 

the FOMC-submitted their assessments, under each 

participant's judgment of appropriate monetary 

policy, of real output growth, the uuemployment rate, 

inflation, and the target federal funds mte for each year 

from 2012 through 2014 and over the longer run. 

These assessments were based on information available 

at the time of the meeting and participants' individual 

assumptions about the factors likely to affect economic 

outcomes. The longer-run projections represent each 

participant's judgment of the mte to which each variable would be expected to converge, over time, under 

appropriate monetary policy and in the absence of further shocks to the economy. "Appropriate monetary 

policy" is defined as the future path of policy that participants deem most likely to foster outcomes for economic activity and inflation that best satisfy their individual interpretations of the Federal Reserve's 

objectives of maximum employment and stable prices. 

Overall, the assessments that FOMC participants 

submitted in June indicated that, under appropriate 

monetary policy, the pace of economic expansion over 

the 2012-14 period would likely continue to be moderate and inflation would remain subdued (see table 1 

and figure I). Participants judged that the growth rate 

of real gross domestic product (GDP) would pick up 

gradually and that the unemployment rate would edge 

down very slowly. Participants projected that inflation, 

as measured by the annual change in the price index 

for personal consumption expenditures (PCE), would 

run close to or below the FOMC's longer-run inflation 

objective of 2 percent. 

As shown in figure 2, most participants judged that 

highly accommodative monetary policy was likely to 

be warranted over the forecast period. In particular, 

13 participants thought that it would be appropriate 

for (he first increase in the target federal funds rate to 

occur during 2014 or later. A majority of participants 

judged that appropriate monetary policy would involve 

an extension of the maturity extension program 

(MEP) through the end of 2012. 

Overall, participants judged the uncertainty associa(ed with the outlook for real activity and the unemployment rate to be unusually high relative to historical 

norms, with the risks weighted mainly (oward slower 

economic growth and a higher unemployment rate. 

Table 1. Economic projections of l-ooeral Reserve Board members and Federal Reserve Bank presidents, June 2012 

Penoen' 

Central tendencyl Rangc2 

Variable I I I I 2012 2013 2014 Longer run 2012 2013 2014 Longer run 

Cbangeinrea1GDP. 1.9 to 2.4 2.2 to 2.8 3.0to 3.5 2.3102.5 1.6t02.5 2.2103.5 2.8 to 4.0 2.2 to 3.0 

April projtx:tion . 2.4 to 2.9 2.7 to 3.1 3,\ to 3,6 2.3 {02.6 2.1 to 3.0 2.4 to 3.8 2.9 to 4.3 22 to 3.0 

Unemployment rate . 8.0 to 8.2 7.5 to 8.0 7.0 to 7.7 5.2 to 6.0 7.8 to 8.4 7.0 to 8.1 6.3 to 7.7 4.9 to 6.3 

April projection . 7.8 to 8.0 7.3 to 7.7 6.7 to 7.4 5.2 to 6.0 7.8 to 8.2 7.0 to 8.1 6.3 to 7.7 4.9 to 6.0 

PCEinfiation .. , . ., .. 1.2 to 1.7 1.5 to 2.0 1.5 to 2.0 2.0 1.2 to 2.0 L5t02.1 1.5 tol.2 2.0 

April projection . 1.9 to 2.0 1.6 to 2.0 1,7 to 2.0 2.0 1.8 to 2.3 1.5 to 2.1 1.5 to 2,2 2.0 

Core PCE inflation3 1.7 to 2.0 1.6 to 2.0 1.6 to 2.0 ! 1.7 to 2.0 IAto 2.1 1.5 to 2.2 1 April projection ...... ..... 1.8 to 2,0 1.7 to 2,0 1.8 to 2.0 1.7 to 2.0 1.6 to 2.1 L7t02.2 

Note: Projections of change in real gros. .. dome:;tic product (GOP) and projections for both mea.~tlres of inflation are from the fourth quarter of the previOIL<': year to the fourth quarter of th~ year indicated. PCE inJlauon and cure PCE inflation arc the ~rcenl.age rales of change in, respectively. the price index lor personal consumption expenditures (PCE) and tbe price index. for PCE ex.cJuding food and energy. Projections tor the unemployment rate aR for the average civilian unemployment rate in the fourth quarter of the year indicated. Each participant's projections arc based on his or her assessment of appropriate monetary policy. LongcNun projections represent each participant's assessment of the rate to which each variable would be expected to converge under appropriate monetary policy and in the absence of further shocks to 

the economy. The April projections were made in conjunction with the meeting of the Federal Open Market Committee on April 24-25. 2012. 

1. Thecentral tendency excludes the three highest and three lowest projection!> for each variable in each year. 

2. The range for a variable in a giv(..'ll year includes all participa.nt.~' projections, from lowest to highcst, for that variable in that year. 

3. Lungerarun p!(Jjoctiuns lor .:;ure PCE inllation are not collected. 
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46 Monetary Policy Report to the Congress 0 July 2012 

Many participants also viewed the uncertainty surrounding their projections for inflation to be greater 

than normal, but most saw the risks to inflation to be 

broadly balanced. 

The Outlook for Economic Activity 

Conditional upon their individual assumptions about 

appropriate monetary policy, participants judged that 

the economy would continue to expand at a moderate 

pace in 2012 and 2013 before picking up in 2014 to a 

pace somewhat above what participants view as the 

longer-run rate of output growth. The central tendency 

of their projections for the change in real GDP in 2012 

was 1.9 to 2.4 percent, lower than in April. Many participants characterized the incoming data~specially 

for household spending and the labor market-as having been weaker than they had anticipated in April. In 

addition, most noted that the worsening situation in 

Europe was leading to a slowdown in global economic 

growth and greater volatility in financial markets. 

Compared with their April submissions, most participants lowered their medium-run projections of economic activity somewhat. The central tendencies of 

participants' projections of real economic growth in 

2013 and 2014 were 2.2 to 2.8 percent and 3.0 to 

3.5 percent, respectively. The central tendency for the 

longer-run rate of increase of real GDP was 2.3 to 

2.5 percent, little changed from April. Participants 

cited several headwinds that were likely to hold back 

the pace of economic expansion over the forecast 

period, including the difficult fiscal and financial situation in Europe, a still-depressed housing market, tight 

credit for some borrowers, and fiscal restraint in the 

U oited States. 

Consistent with the downward revisions to their projections for real GDP growth in 2012 and 2013, nearly 

all participants marked up their assessments for the 

rate of unemployment. Participants projected the 

unemployment rate at the end of 2012 to remain at or 

slightly below recent levels, with a central tendency of 

8.0 to 8.2 percent, somewhat higher than their April 

submissions. Participants anticipated gradual improvement in labor market conditions by 2014, but even so, 

they generally thought that the unemployment rate at 

the end of that year would still lie well above their individual estimates of its longer-run normal level. The 

central tendencies of participants' forecasts for the 

unemployment rate were 7.5 to 8.0 percent at the end 

of 2013 and 7.0 to 7.7 percent at the end of 2014. The 

central tendency of participants' estimates of the 

longer-run normal rate of unemployment that would 

prevail under the assumption of appropriate monetary 

policy and in the absence of further shocks to the 

economy was 5.2 to 6.0 percent, unchanged from 

April. Most participants projected that the gap 

between the current unemployment rate and their estimates of its longer-run normal rate would be closed in 

five or six years, a couple judged that less time would 

be needed, and one thought more time would be necessary because of the persistent headwinds impeding the 

economic expansion. 

Figures 3.A and 3.B provide details on the diversity 

of participants' views regarding the likely outcomes for 

real GDP growth and the unemployment rate over the 

next three years and over the longer run. The dispersion in these projections reflects differences in participants' assessments of many factors, including appropriate monetary policy and its effects on the economy, 

the underlying momentum in economic activity, the 

spill-over effects of the fiscal and financial situation in 

Europe, the prospective path for U.S. fiscal policy, the 

extent of structural dislocations in the labor market, 

and the likely evolution of credit and financial market 

conditions. Compared with their April assessments, the 

range of participants' forecasts for the change in real 

GDP in 2012 and 2013 shifted lower, while the dispersion of individual forecasts for growth in 2014 was 

about unchanged. Consistent with the downward shift 

in the distribution of forecasts for economic growth, 

the distribution of projections for the unemployment 

rate shifted up in 2012 and 2013 and, to a lesser extent, 

in 2014. As in April, the dispersion of estimates for the 

longer-run rate of output growth was fairly narrow, 

generally in a range of 2.2 to 2.7 percent. In contrast, 

participants' views about the level to which the unemployment rate would converge in the longer run were 

more diverse, reflecting, among other thing~ different 

views on the outlook for labor supply and the structure 

of the labor market. 

The Outlook for Inflation 

Participants' views about the medium-run outlook for 

inflation under the assumption of appropriate monetary policy were little changed from April. However, 

nearly all of them marked down their assessment of 

headline inflation in the near term, pointing to recent 

declines in the prices of crude oil and gasoline that 

were sharper than previously projected. Almost all participants judged that both headline and core inflation 

would remain subdued over the 2012-14 period, running at rates at or below the FOMC's longer-run 

objective of 2 percent. Some participants noted that 
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-i;' 

11 

II 
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1\1 

I-j 

11 

H) 
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inflation expectations had remained stable, and several 

pointed to resource slack and moderate increases in 

labor compensation as sources of restraint on prices. 

Specifically, the central tendency of participants' projections for inflation, as measured by the PCE price 

index, moved down in 2012 to 1.2 to 1.7 percent and 

was little changed in 2013 and 2014 at 1.5 to 2.0 perccnt. The central tendencies of the forecasts for core 

inflation were broadly the same as those for the headline measure in 2013 and 2014. 

Figures 3.C and 3.D provide information about the 

diversity of participants' views about the outlook for 

inflation. Relative to the assessments compiled in 

April, the projections for headline inflation shifted 

down in 2012, reflecting the declines in energy prices. 

The distributions of participants' projections for headline and core inflation in 2013 and 2014 were slightly 

lower than those reported in April. 

Appropriate Monetary Policy 

As indicated in figure 2, most participants judged that 

exceptionally low levels of the federal funds rate would 

remain appropriate at least until late 2014. In particular, seven participants thought that it would be appropriate to commence policy firming in 2014, while 

another six participants thought that the first increase 

in the target federal funds rate would not be warranted 

unti12015 (upper panel). Eleven participants indicated 

that the appropriate federal funds rate at the end of 

2014 would be 75 basis points or lower (lower panel), 

and those who judged that policy liftoff would not 

occur until 2015 thought the federal funds rate would 

be 1 y, percent or lower at the end of that year. As in 

April, six participants judged that economic conditions 

would warrant an increase in the target federal funds 

rate in either 2012 or 2013 in order to achieve the 

Committee's statutory mandate. Those participants 

judged that the appropriate value for the federal funds 

rate would range from I 'Ii to 3 percent at the end of 

2014. 

All participants reported levels for the appropriate 

target federal funds rate at the end of 2014 that were 

well below their estimates of the level expected to prevail in the longer run. Estimates of the longer-run target federal funds rate ranged from 3 to 4'1i percent, 

reflecting the Committee's inflation objective of 2 percent and participants' judgments about the longer-run 

equilibrium level of the real federal funds rate. 

Participants also provided qualitative information 

on their views regarding the appropriate path of the 

Federal Reserve's balance sheet. Of the 12 participants 

whose assessments of appropriate monetary policy 

Board of Governors of the Federal Reserve System 49 

included additional balance sheet policies, II indicated 

that their assumptions incorporated an extension 

through the end of 2012 of the MEP, and 2 participants conditioned their economic forecasts on a new 

program of securities purchases. Two indicated that 

they would consider such purchases in the event that 

the economy did not make satisfactory progress in 

improving labor market conditions or in the event of a 

significant deterioration in the economic outlook or a 

further increase in downside risks to that outlook. 

Almost all participants assumed that the Committee 

would carry out the normalization of the balance sheet 

according to the principles approved at the June 2011 

FOMC meeting. That is, prior to the first increase in 

the federal funds rate, the Committee would likely 

cease reinvesting some or all principal payments on 

securities in the System Open Market Account 

(SOMA), and it would likely begin sales of agency 

securities from the SOMA sometime after the first rate 

increase, aiming to eliminate the SOMNs holdings of 

agency securities over a period of three to five years. In 

general, participants linked their preferred start dates 

for the normalization process to their views for the 

appropriate timing for the first increase in the target 

federalfunds rate. One participant who thought that 

the liftoff of the federal funds rate should occur relatively soon indicated that the reinvestment of maturing 

securities should continue for a time after liftoff. 

The key factors informing participants' individual 

assessments of the appropriate setting for monetary 

policy included their judgments regarding the maximum level of employment, the extent to which current 

conditions had deviated from mandate-consistent levels, and participants' projections of the likely time 

horizon necessary to return employment and inBation 

to such levels. Several participants noted that their 

assessments of appropriate monetary policy reflected 

the subpar pace of the economic expansion and the 

persistent shortfall in aggregate demand since the 

2007-09 recession, and two commented that the neutrallevel of the federal funds rate was likely somewhat 

below its historical norm. One participant expressed 

concern that a protracted period of very accommodative monetary policy could lead to a bnildup of risks in 

the financial system. Participants also noted that 

because the appropriate stance of monetary policy 

depends importantly on the evolution of real activity 

and inflation over time, their assessments of the appropriate future path of the federal funds rate and the balance sheet could change if economic conditions were 

to evolve in an unexpected manner. 

Figure 3.E details the distribution of participants' 

judgments regarding the appropriate level of the target 
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1l 

j~ 

11' 
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11 

-~1U 
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il 
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federal funds rate at the end of each calendar year 

from 2012 to 2014 and over the longer run. Most participants judged that economic conditions would warrant maintaining the current low level of the federal 

funds rate through the end of 2013. Views on the 

appropriate level of the federal funds rate at the end of 

2014 were more widely dispersed, with II participants 

seeing the appropriate level of the federal funds rate as 

Y. percentage point or lower and 4 of them seeing the 

appropriate rate as 2 percent or higher. Those who 

judged that a longer period of very accommodative 

monetary policy would be appropriate generally projected that the unemployment rate would remain further above its longer-run normal level at the end of 

2014. In contrast, the 6 participants who judged that 

policy firming should begin in 2012 or 2013 indicated 

that the Committee would need to act soon to keep 

inflation near the FOMC's longer-run objective of 

2 percent and to prevent a rise in inflation expectations. 

Uncertainty and Risks 

Nearly all participants jndged that their current level of 

uncertainty about GDP growth and unemployment 

was higher than was the norm during the previous 

20 years (figure 4).'4 About half of all participants 

judged the level of uncertainty associated with their 

inflation forecasts to be higher as well, while another 

eight participants viewed uncertainty about inflation as 

broadly similar to historical norms. The main factors 

cited as underlying the elevated uncertainty about economic outcomes were the ongoing fiscal and financial 

situation in Europe, the outlook for fiscal policy in the 

United States, and a general slowdown in global economic growth, including the possibility of a significant 

slowdown in China. As in April, participants noted the 

difficulties associated with forecasting the path of the 

U.S. economic recovery following a financial crisis and 

14. Table 2 provides estimates of the forecast uncertainty for the 

change in real GDP, the unemployment rate, and total consumer 

price inflation over the period from 1992 to 201 L At the end of this 

summary, the box "Forecast Uncertainty" discusses the sources and 

interpretation of uncertainty in the economic forecasts and explains 

the approach used to assess the uncertainty and risks attending the 

participants' projections. 

Board of Governors of the Federal Reserve System 53 

Table 2. Average historical projection error ranges 

Percentage f!oints 

Variable 2012 

Change in real GDpl ±l.O 

Unemployment mte1 . ±O.4 

Total consumer priccs2 • ±O.S 

2013 2014 

±J.6 ±L7 

±1.2 ±1.7 

±LO ±I.l 

Note: Error ranges shown are measured as plus or minus the root mean squarcderror of projections for 1992 through 2011 that wen: rcleascd in the summer by various private and government forecasters. As described in the box "Forecast Uncertainty," under certain ass.umptions, there is anout a 70 percent prohabil· ity that actual oulcomes Ji)r real GOP, unt:mpk!ymenl, and consumer prices will be in ranges implied by the average size of projection errors made in the pa~t. Fur- ther information is in David Reifschneider and Peter Tulip (2o(7), "Gauging thc 

Uncertainty of the Economic Outlook from Historical Forecasting Errors," 

Finance and Economics Di~ussion Series 2007-60 (Washington: Hoard of Gover- nors of the Federal Reserve System, November). 

L Definitions of variables are in the general note to table 1. 

2. Measure is the overall consumer price index, the price measure that has been 

mo);t widely used in government and private economic forecast'\. Projection is per~ 

cent ..:hangt!, fourlb quarter of the previous year 10 the fourth quarter of tht;: year 

indicated. 

recession that differed markedly from recent historical 

experience. Several commented that in the aftermath of 

the financial crisis, they were more uncertain about the 

level of potential output and its trend rate of growth. 

A majority of participants reported that they saw 

the risks to their forecasts of real GDP growth as 

weighted toward the downside and, accordingly, the 

risks to their projections of the unemployment rate as 

tilted to the upside. The most frequently identified 

sources of risk were the situation in Europe, which 

many participants thought had the potential to slow 

global economic activity, particularly over the near 

term, and the fiscal situation in the United States. 

Most participants continued to judge the risks to 

their projections for inflation as broadly balanced, with 

several highlighting the recent stability of inflation 

expectations. However, five participants saw the risks 

to inflation as tilted to the downside, a larger number 

than in April; a couple of them noted that slack in 

resource markets could turn out to be greater or could 

put more downward pressure on inflation tban they 

were anticipating. Two participants saw the risks to 

inflation as weighted to the upside, in light of concerns 

about U.S. fiscal imbalances, the current highly accommodative stance of monetary policy, or the Committee's ability to effectively remove policy accommodation when it becomes appropriate to do so. 
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IS 

Ii 
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Forecast Uncertainty 

The economic projections provided by the mem· 

bers of the Board of Governors and the presidents 

of the Federal ReselVe Banks inform discussions of 

monetary policy among policymakers and can aid 

public understanding of the basis for policy 

actions. Considerable uncertainty attends these 

projections, however. The economic and statistical 

models and relationships used to help produce 

economic forecasts are necessarily imperfect 

descriptions of the real world, and the future path 

of the economy can be affected by myriad unfore~ 

seen developments and events. Thus, in setting the 

stance of monetary policy, participants consider 

not only what appears to be the most likely. economic outcome as embodied in their projections, 

but also the range of alternative possibilities, the 

likelihood of their occurring, and the potential 

costs to the economy should they occur. 

Table 2 summarizes the average historical accu~ 

racy of a range of forecasts, including those 

reported in past MonetaI}' Policy Reports and those 

prepared by the Federal Reserve Board's staffin 

advance of meetings of the Federal Open Market 

Committee. The projection error ranges shown in 

the table illustrate the considerable uncertainty 

associated with economic forecasts. For example, 

suppose a participant projects that real gross 

domestic product (GOP) and total consumer prices 

will rise steadily at annual rates of/ respectively, 

3 percent and 2 percent. If the uncertainty attend~ 

ing those projections is similar to that experienced 

in the past and the risks around the projections are 

broadly balanced, the numbers reported in table 2 

would imply a probability of about 70 percent that 

actual GDP would expand within a range of 2.0 to 

4.0 percent in the current year, 1.4 to 4.6 percent 

Board of Governors of the Federal Reserve System 55 

in the second year, and 1.3 to 4.7 percent in the 

third year. The corresponding 70 percent confi~ 

dence intervals for overall inflation would be 

1.2 to 2.8 percent in the current year, 1.0 to 3.0 percent in the second year, and 0.9 to 3.1 percent in 

the third year. 

Because current conditions may differ from 

those that prevailed, on average, over history, par· 

ticipants provide judgments as to whether the 

uncertainty attached to their prOjections of each 

variable is greater than, smaller than, or broadly 

similar to typicallevefs of forecast uncertainty in 

the past, as shown in table 2. Participants also provide judgments as to whether the risks to their pro· 

jections are weighted to the upside, are weighted 

to the downside, or are broadly balanced. That iSt 

participants judge whether each variable is more 

likely to be above or below their projections of the 

most likely outcome. These judgments about the 

uncertainty and the risks attending each participant's projections are distinct from the diversity of 

participants' views about the most likely outcomes. 

Forecast uncertainty is concerned with the risks 

associated with a particular projection ratherthan 

with divergences across a number of different 

projections. 

As with real activity and inflation, the outlook 

for the future path of the federal funds rate issubject to considerable uncertainty. This uncertainty 

arises primarily because each participant's assess~ 

ment of the appropriate stance of monetary policy 

depends importantly on the evolution of real activity and inflation overtime. If economic conditions 

evolve in an unexpected manner, then assessments 

of the appropriate setting of the federal funds rate 

would change from that pOint forward. 
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Abbreviations 

ABCP 

ABS 

AFE 

AIG 

BEA 

BHC 

BOE 

BOJ 

CCAR 

CDS 

C&I 

CMBS 

CP 

CRE 

DPI 

ECB 

EME 

E&S 

ESM 

EU 

FOMC 

FRBNY 

FSOC 

GDP 

GSE 

HARP 

IMF 

lPO 

MBS 

MEP 

Michigan survey 

NIPA 

NPR 

PCE 

asset-backed commercial paper 

asset-backed securities 

advanced foreign economy 

American International Group, Inc. 

Bureau of Economic Analysis 

bank holding company 

Bank of England 

Bank of Japan 

Comprehensive Capital Analysis and Review 

credit default swap 

commercial and industrial 

commercial mortgage-backed seeurities 

commercial paper 

commercial real estate 

disposable personal income 

European Central Bank 

emerging market economy 

equipment and software 

European Stability Mechanism 

European Union 

Federal Open Market Committee; also, the Committee 

Federal Reserve Bank of New York 

Financial Stability Oversight Council 

gross domestic product 

government-sponsored enterprise 

Home Affordable Refinance Program 

International Monetary Fund 

initial public offering 

mortgage-backed securities 

maturity extension program 

Thomson Reuters/University of Michigan Surveys of Consumers 

national income and product accounts 

notice of proposed rulemaking 

personal consumption expenditures 

57 
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58 Monetary Polky Report to the Congress 0 July 2012 

PRI 

SCOOS 

SEP 

SLOOS 

SOMA 

S&P 

STBL 

TALF 

Institutional Revolutionary Parly 

Senior Credit Officer Opinion Survey on Dealer Financing Terms 

Summary of Economic Projections 

Senior Loan Officer Opinion Survey on Bank Lending Practices 

System Open Market Account 

Standard & Poor's 

Survey of Terms of Business Lending 

Term Asset-Backed Securities Loan Facility 
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76116.075

Question for The Honorable Ben S. Bernanke, Chainnan, Board of Governors of the 

Federal Reserve System, from Representative Cleaver: 

1. The LIBOR by virtue of the manner in which it is calculated seems to be open to 

distortion. What proposals would you put forward in order to improve the credibility and 

validity of the rate? 

A number of efforts are under way to examine the issues surrounding the calculation of LIB OR 

and to determine the appropriate next steps for refonn of LIB OR and potentially other fmancial 

market benchmarks. These efforts include work being done by authorities in the United 

Kingdom, the Bank for Intemational Settlements, the International Organization of Securities 

Commissions, and other international agencies. The Federal Reserve Board has taken part in 

discussions of possible refonns of LIBOR in international forums including the Economic 

Consultative Committee, a group of central bank governors, and the Financial Stability Board. 

Domestically, the Board and other Financial Stability Oversight Council agencies have 

cooperated in studying the risks surrounding the current LIBOR framework and the alternatives 

that are being considered. 

Authorities are still grappling with a number of issues. For example, if the decision is made to 

fix the current system, then governance of the process, both within rate-submitting banks and 

within the body that oversees the calculation, must be improved. In addition, changes in the 

calculation may also be desirable. If, on the other hand, the decision is made to replace LIBOR 

with an alternative benchmark, there are a host of other issues to address. For example, how to 

transition to the alternative, whether the alternative will be transaction based or will remain an 

indicative quote, and how to handle legacy contracts. 

Finally, an important question is who should oversee the refonn process. Because LIBOR and 

other similar benchmarks were developed by, and are primarily used by, the private sector, the 

private sector will likely playa major role in the LIBOR refonn efforts, though UK regulators 

will also playa key role in ensuring the refonns are adeqnate and in the public interest. The 

Federal Reserve, like other central banks, has an interest in the outcome of the refonn efforts, 

given our monetary policy and financial stability responsibilities. We will continue to carefully 

monitor risks arising from and options to refonn LIBOR and other benchmarks, and we will be 

prepared to provide support to refonn efforts as necessary and appropriate. 
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76116.080

uestions for The Honorable Ben S. Bernank 

Federal Reserve S stem from Re resentativ 

1. While I understand that the Federal Reserve does not have internal mechanisms for 

measuring the creditworthiness of intellectual property held in general intangible lines, is 

the Federal Reserve taking any steps for these assets to be included in measuring overall 

reserve capital by means of impacting risk weighted asset calculations? Of investment 

grade counterparties were willing to monetize the liquid value of these collateral pools, does 

the Federal Reserve believe that these knowledge economy assets could be included in 

assessments of banking capital adequacy? 

Consistent with the practice of the other federal banking agencies, the Board recognizes only 

limited forms of collateral in the calculation of a banking organization's risk-weighted assets for 

risk-based capital purposes. The Board may take other forms of collateral into consideration in 

evaluating the risks inherent in a banking organization's exposures and assessing its capital 

adequacy more generally. 

Revisions to the regulatory capital framework recently proposed by the federal banking agencies 

would provide for greater recognition of financial collateral. See 77 Federal Register 52888, 

52909,52958 (August 30,2012). The proposal would expand the list of eligible forms of 

collateral under the agencies' risk-based capital rules to include additional liquid and readily 

marketable instruments, such as certain types of debt securities and publicly-traded equity 

securities. Banking organizations would be required to meet certain prudential requirements to 

recognize the collateral, such as having a perfected, first priority interest in the collateral. The 

expanded definition offmancial collateral under the proposed rules does not include intellectual 

property held in general intangible liens as a potential form of financial collateral. 

The Board is in the process of reviewing carefully the comments on the proposal. The Board is 

not aware that intellectual property rights held in general intangible liens currently take the form 

ofliquid and readily marketable instruments. We will continue to monitor developments in this 

market. 

2. During your appearance before the House Committee on Financial Services in 

March 2011, you answered one of my questions by stating that we know from experience 

that small banks are often the ones that are best situated to provide credit to small 

businesses so they can expand and create jobs, especially in rnral communities. 

Based on the Federal Reserve and other regulators recent proposal to extend the Basel III 

capital requirements to all banks, do you foresee any disproportionate effects on smaller 

banks and the communities they serve? Has the Federal Reserve or another regulatory 

authority performed an analysis on how these capital thresholds for smaller institutions 

will affect access to capital and job creation in rnral communities? 

Many requirements in the Basel III proposal are focused on larger organizations and would not 

be applicable to community banking organizations. These requirements include the proposed 

countercyclical capital buffer, the proposed supplementary leverage ratio, proposed enhanced 
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disclosure requirements, proposed enhancements to the advanced approaches risk-based capital 

framework, stress testing requirements, a systemically important fInancial institution capital 

surcharge, and market risk capital reforms. These changes, along with other recent regulatory 

capital enhancements, would require large, systemically important banking organizations to hold 

signifIcantly higher levels of capital relative to other organizations. 

In developing the Basel III-based capital requirements, the Board and the other federal banking 

agencies conducted an impact analysis based on regulatory reporting data to estimate the change 

in capital that banking organizations would be required to hold to meet the proposed minimum 

capital requirements. Based on the agencies' analysis, the vast majority of banking organizations 

currently would meet the fully phased-in minimum capital requirements, and those organizations 

that would not meet the proposed minimum requirements would have time to adjust their capital 

levels by the end of the transition period. More specifically with regard to smaller banking 

organizations, for bank holding companies with less than $10 billion in assets that meet the 

current minimum regulatory capital requirements, the analysis indicated that more than 

90 percent of organizations would meet the new 4.5 percent minimum common equity tier 1 ratio 

today. In addition, quantitative analysis by the Macroeconomic Assessment Group, a working 

group of the Basel Committee on Banking Supervision, found that the stronger Basel III capital 

requirements would lower the probability of banking crises and their associated economic output 

losses while having only a modest negative impact on gross domestic product and lending costs, 

and that the potential negative impact could be mitigated by phasing in the requirements over 

time. 

Nonetheless, the Board is concerned about the potential effect of the Basel III proposals on 

community banks. The Board is still in the process of reviewing the comments it has received on 

the proposal, including those regarding the likely impact on smaller institutions. The Board will 

be mindful of these comments when considering potential refinements to the proposal and will 

work to appropriately balance the benefIts of a revised capital framework against its potential 

costs, including further tailoring the requirements for smaller institutions as appropriate. 

3. Additionally, during your appearance in March 2011, we spoke about what the Federal 

Reserve has done to curb perceived micromanagement by bank examiners and regulators. 

Can you provide details on what steps the Federal Reserve has taken over the past two 

years to tailor its regulatory requirements and examination process based on 

recommendations and concerns that you have heard from community banks? 

In recent years, the Board has taken a number of steps to reduce regulatory burden on, and 

enhance its communication with, community banks. In 2009, the Board established a 

subcommittee to focus on supervisory approaches to community and regional banks to ensure 

that their views on the supervisory process are considered. This subcommittee is led by Board 

Governors Elizabeth Duke and Sarah Bloom Raskin. A primary goal of the subcommittee is to 

ensure that the development of supervisory guidance is informed by an understanding of the 

unique characteristics of community and regional banks and consideration of the potential for 

excessive burden and adverse effects on lending. In addition, in 2010, the Board established the 
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Community Depository Institutions Advisory Council (CDIAC) to provide input on the 

economy, lending conditions, and other issues of interest to community banks. Members include 

representatives of banks, thrift institutions, and credit unions serving on local advisory councils 

at the 12 Federal Reserve Banks. One member of each of the Reserve Bank councils is selected 

to serve on the CDlAC, which meets twice a year with the Board in Washington, D.C. 

Feedback from community bankers has consistently pointed to increasing regulatory burden as a 

concern and threat to the viability of the community bank model. Last year, the Board's 

subcommittee on community and regional banks asked that a series of initiatives be developed to 

clarify regulatory expectations, alleviate regulatory burdens where possible, and reduce the 

potential that regulatory actions could curtail lending. In response, Federal Reserve staff 

initiated a number of projects to enhance supervision practices for community banks and 

alleviate some of the burdens that have been of the most immediate concern. 

Several of these projects aim to revise or clarifY guidance. These have included the development 

and issuance of guidance to reiterate when supervisory rating upgrades may be considered for 

community banks recovering from the effects of the recent crisis, to enhance the transparency 

and consistency of assessments of the adequacy of banks' allowances for loan and lease losses, 

and to clarify capital planning expectations for community banks. Others projects are intended 

to improve our examination processes by reviewing exam preparation procedures to ensure that 

report findings are clearly communicated and fully consistent with infonnation provided to 

bankers during exit meetings, developing and adopting common teChnology tools across the 

System to improve efficiency and potentially reduce burden on supervised companies, and 

evaluating applications-processing procedures to enhance transparency and identify opportunities 

for streamlining. Overall, these efforts are intended to ensure a rigorous, but balanced, approach 

to safety and soundness supervision that fosters a stable, sound, and vigorous community bank 

population. 
130 


76116.083

uestions for The Honorable Ben S. Bernanke 

Federal Reserve S stem from Re resentative cCarth: 0,, _______ 

1. The recent CFTC and DOJ Settlements reached with Barciays regarding their 

manipulation of the LIDOR index, still leaves outstanding issue of ensuring that such 

manipulation foes not occur again. Recognizing this is an international issue and will 

require cooperation from European regulators, 

• What changes do you feel are necessary to better detect and ultimately avoid future 

manipulation of the LIDOR index? 

A number of efforts are under way to examine the issues surrounding the calculation of UBOR 

and to detennine the appropriate next steps for refonn of LIDOR and potentially other financial 

market benchmarks. These efforts include work being done by authorities in the United 

Kingdom, the Bank for International Settlements, the International Organization of Securities 

Commissions, and other international agencies. The Federal Reserve Board has taken part in 

discussions of possible reforms of LID OR in intemational forums including the Economic 

Consultative Committee, a group of central bank governors, and the Financial Stability Board. 

Domestically, the Board and other Financial Stability Oversight Council agencies have 

cooperated in studying the risks surrounding the current LIBOR framework and the alternatives 

that are being considered. 

Authorities are still grappling with a number of issues. For example, if the decision is made to 

fix the current system, then governance of the process, both within rate-submitting banks and 

within the body that oversees the calculation, must be improved. In addition, changes in the 

calculation may also be desirable. If, on the other hand, the decision is made to replace LIBOR 

with an altemative benchmark, there are a host of other issues to address. For example, how to 

transition to the alternative, whether the alternative will be transaction based or will remain an 

indicative quote, and how to handle legacy contracts. 

Finally, an important question is who should oversee the refonn process. Because LIDOR and 

other similar benchmarks were developed by, and are primarily used by, the private sector, the 

private sector will likely playa major role in the LIBOR refonn efforts, though UK regulators 

will also playa key role in ensuring the refonns are adequate and in the public interest. The 

Federal Reserve, like other central banks, has an interest in the outcome of the refonn efforts, 

given our monetary policy and financial stability responsibilities. We will continue to carefully 

monitor risks arising from and options to refonn LIBOR and other benchmarks, and we will be 

prepared to provide support to refonn efforts as necessary and appropriate. 

2. In a recent Wall Street Journal article "Fed Wrestles With How Best to Bridge U.S. 

Credit Divide," June 19, 2012, the point is made that the Federal Reserve's low interest 

rate policy has not improved access to credit for those who need it most - Americans of 

modest means and lower credit scores, and has not influenced the credit divide in this 

country. 
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-2-

• What is the Fed's responsibility in achieving a more equitable spread of the benefits 

from the policies put in place to spur economic growth? 

The Federal Reserve has multiple responsibilities in this regard. First, the Federal Reserve has 

responsibility for pursuing the monetary policy mandates given to it by the Congress, namely 

price stability and maximum sustainable employment. The experience of the last several years 

also demonstrates conclusively how critical fmancial stability is to the achievement ofits 

monetary policy mandate. The Federal Reserve also has important supervisory responsibilities. 

As important as these policy responsibilities are, they are not a panacea The economy faces 

multiple important challenges, and all economic policymakers should ensure that they are using 

every available tool to work toward a more rapid retum of a durable and broadly shared 

prosperity. 

• What policy changes can be made to bridge the credit divide, while still preserving 

safety and soundness? 

The Federal Reserve has long been oriented toward promoting these objectives. We do that 

through our microprudential supervision of financial institution; through our development and 

conduct of macroprudential policy; and through our conduct of monetary policy. As I have said 

many times, the recovery is proceeding too slowly for anyone's satisfaction, and I can assure you 

that the Federal Reserve will not stint in its efforts toward the achievement of our various policy 

objectives. 

3. In addition to the liquidity support the Federal Reserve has provided the European 

Central Bank, what more do you feel could or should the United States do to encourage or 

support the Eurozone financial crisis response? 

European leaders have recently taken some important steps toward resolving their crisis, 

including an agreement on additional aid to Greece and some progress toward banking union. 

The Europeans will need to build on that progress by working to fulfill their commitments to 

support growth, financial stability, and fiscal and financial integration in the region. The Federal 

Reserve and the Treasury are in contact with our counterparts in Europe to remain apprised of 

the situation there, to consult as appropriate, and to assist in monitoring of potential spillovers to 

the U.S economy. In the event that financial stresses in Europe were to worsen and threaten the 

U.S. economic recovery or U.S. financial stability, the Federal Reserve is prepared to use its 

policy tools as necessary to address strains in financial markets and support the flow of credit to 

households and firms. The Federal Reserve and several other major central banks have already 

established swap lines that allow the foreign central banks to provide dollar liquidity to banks in 

their jurisdictions. These facilities should help reduce pressure on dollar funding markets in the 

United States, which are important for U.S. households and businesses. In addition to the 

liquidity support that the Federal Reserve has supplied, we believe that the United States can also 

contribute to the health of the European economies, and thus support the Eurozone financial 

crisis response, by bolstering our own economic recovery. 
132 


76116.076

Ouestions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System. from Representative Paul: 

1. What items constitute the "Other Federal Reserve assets" line item in Table 1 of the 

weekly Federal Reserve Statistical Release H.4.1 Factors Affecting Reserve Balances of 

Depository Institutions and Condition Statement of Federal Reserve Banks? Please 

provide as detailed a categorized list as possible? 

"Other Federal Reserve assets" ("other assets") include assets denominated in foreign currencies; 

premiums paid on securities bought; accrued interest on other accounts receivable; Reserve Bank 

premises and operating e~uipment less allowances for depreciation; and, until recently, floatrelated as-of adjustments. Until January 2009, "other assets" also included the currency swaps 

with other central banks. For reference, the Board of Governors' Credit and Liquidity Programs 

and the Balance Sheet public website presents a summary of the H.4.1 statistical release with an 

interactive guide (http://www.federalreserve.gov/monetarypolicylbstfedsbalancesheet.htm). 

2. The "Other Federal Reserve assets" line item increased from approximately 540 billion 

in early 2009 to roughly 5100 billion in early 2010, remaining at that level throughout 2010. 

What were the causes for the increase in the "Other Federal Reserve assets" line items over 

the 2009-2010 period? 

You noted that between 2009 and early 20 I 0, "other assets" increased. Indeed, between 

January 28, 2009, and the present, "other assets" have increased by roughly $150 billion. The 

increase primarily reflects an increase in unamortized premiums on securities held in the Federal 

Reserve's System Open Market Account portfolio. The Federal Reserve purchases securities in 

the open market at market-determined prices. The market price of a security can be expressed as 

the face value of that security plus a premium or a discount, depending on whether the market 

price of the security is above or below the face value on the date of purchase. On the H.4.1 

statistical release, we report the face value of the securities, and the premium or discount at the 

time of purchase is separately reported under "other assets." This accounting treatment has been 

in place for decades. 

Since early 2009, the Federal Reserve has engaged in large-scale asset purchases in an effort to 

ease overall financial conditions and to provide support for the economic recovery. Because the 

market prices of most of the securities that were purchased were greater than the face value of 

those securities, "other assets" have increased reflecting the accumulation of premiums as our 

holdings of securities have increased? 

I As one part of an effort to simplifY the administration of reserve requirements and thereby reduce burden on the 

banking sector, the Federal Reserve eliminated as-of adjustments on July 12,2012. Additional infonnation about 

reserves simplifications can be found at http://www.federalreserve.gov/newsevents/press/otherI20120405a.htm 

2 The Federal Reserve publishes the details ofal! ofits securities holdings on the public website of the Federal 

Reserve Bank of New York (http://www.newyorkfed.orglmarkets/somalsysopen_accholdings.btml). 
133 


76116.077

-2-

3. The "Other Federal Resenre assets" line item has nearly doubled since early 2011, 

increasing from roughly $100 billion to almost $200 billion. What is (are) the cause(s) for 

this increase in the "Other Federal Resenre assets" line item? 

Please see the response to question 2. 

4. Is the increase in the line item "Other Federal Resenre assets" related in any way to the 

dollar swap lines with foreign central banks or to other assistance to foreign central banks, 

commercial banks, or governments? 

The central bank liquidity swaps that the Federal Reserve has with other central banks have been 

reported separately since January 2009. As a result, the increase in "other assets" since then is 

not related to those swaps, nor is it related to assistance to foreign institutions. 

5. The central bank liquidity swap lines when first drawn upon in 2007 were published in 

the HA.l release with the "Other Federal Resenre assets" line item before being broken out 

into a separate line item in early 2009. Are there some specific facilities, asset types, or 

other categories that could be given their own line item now that the "Other Federal 

Resenre assets" line items had grown so large? 

Although the security premiums at the date of purchase are largely a technical accounting item, 

we are considering whether to report the premiwns on securities separately from other items 

included in the "other assets" category. 
134 


76116.078

Ouestions for The Honorable Ben S. Bernanke. Ch~oard of Governors of the 

Federal Reserve System, from Representative Sc~ \ 

, " 

1. In light ofthe current Weighted Average Matuiity-orU.S. sovereign debt, what is your 

position on encouraging policy makers, particularly those at the Treasury Department, to 

begin issuing extended durations bonds, such as 50-, 75-, and 99-year bonds? Wouldn't 

this direction in monetary policy be consistent with the design and intent of Operation 

Twist, and at the same time reduce U.S. exposure at future refinancing? 

The Treasury Department makes all decisions regarding the issuance of U.S. Treasury debt. As 

an independent agency, the Federal Reserve does not offer advice regarding debt issuance 

matters to the Treasury Department. 

2. At a recent hearing held by the Capital Markets Subcommittee I asked the witnesses 

which issue in the proposed Dodd-Frank rules would most hinder liquidity and a return of 

the securitization markets. Every one of them raised the same concern: the Premium 

Capture Cash Reserve Account, or PCCRA, that's part of your proposed risk retention 

rule. 

Economist Mark Zandi of Moody's Analytics has written that the PCCRA and the 

Qualified Mortgage rule, when taken together - have "the potential to significantly restrict 

the amount of credit available for borrowers without qualified residential mortgages." He 

estimates the mortgage rate impact to borrowers would be between 1 and 4 percent. 

Last month a bipartisan group of six Republicans and six Democrat Senators wrote to you, 

among others, saying that "The PCCRA ... was not envisioned by Congress" and would 

"negatively impact capital formation." I have submitted the letter for the record. My 

question to you, Mr. Chairman, is: given that the PCCRA was not a part of Dodd-Frank 

and was never even contemplated by Congress, don't you think the Fed - which is the only 

one of the six regulators pushing this proposal-should defer to Congress and drop this 

harmful idea? 

On March 31, 2011, the Federal Reserve Board, the Office of the Comptroller of the Currency, 

the Federal Deposit Insurance Corporation, the U.S. Securities and Exchange Commission, the 

Director of the Federal Housing Finance Agency, and the Department of Housing and Urban 

Development (collectively, the "Agencies") invited public comment on a proposal that would 

implement the risk retention requirements under section 941 (b) of the Dodd-Frank Act. Section 

941 of the Dodd-Frank Act generally requires the securitizer of asset-backed securities ("ABS") 

to retain not less than 5 percent of the credit risk of the assets that collateralize those securities. 

The statute also requires that the risk retention regulations prohibit a securitizer from directly or 

indirectly hedging or otherwise transferring the credit risk that the securitizer is required to retain 

with respect to an asset. 

As the Agencies explained in the joint proposed rulemaking to implement section 941 (the 

"Proposed Rule"), the securitizer may sell premium income from assets collateralizing ABS that 

is expected to be generated over the life of a transaction at the inception of a transaction, thereby 
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potentially negating or undennining the securitizer's retention of risk pursuant to the 

requirement. I The Agencies proposed the premium capture cash reserve account ("PCCRA") as 

a way to address this issue and promote meaningful risk retention by prohibiting sponsors from 

receiving compensation at the inception of a securitization transaction for premium income that 

would be generated by the securitized assets over time. As explained in the Proposed Rule, it 

was expected that the PCCRA would better align the interests of securitizers and investors by 

disallowing such upfront compensation and thereby potentially promote sound underwriting. It 

was also expected that the PCCRA would promote simpler and more coherent securitization 

structures. In the Proposed Rule, the Agencies specifically requested comment on the PCCRA 

and sought input on alternative methodologies for achieving similar goals.2 

The Board and the other Agencies received numerous comments on the PCCRA, as well as 

suggestions for modification of the PCCRA and alternative methods for ensuring economically 

meaningful risk retention. In addition, Federal Reserve staffhas met with industry groups and 

other commenters to better understand their concerns about the PCCRA, along with the other 

Agencies. The Board is carefully considering all comments and suggestions on the PCCRA in 

determining how to move forward with the rulemaking. 

3. Our committee's chairman, Spencer Bachus, and my subcommittee chairman, Scott 

Garrett, have repeatedly asked the Fed and the other regulators for an economic analysis 

ofPCCRA. Is that forthcoming? When can we expect it? 

The Board has long been committed to considering the costs and benefits of its rulemaking 

efforts and takes into account all comments and views from the public on the costs and benefits 

of a proposed rulemaking. Indeed, the Board and the other Agencies specifically invited 

comment on the costs and benefits of the risk retention proposal and the PCCRA. As it reviews 

the comments submitted regarding the proposal, including comments on the PCCRA, the Board 

will carefully weigh the costs and benefits of the PCCRA and other alternatives for 

implementing risk retention rules that are consistent with the statutory mandate and purpose. 

4. Does the Federal Reserve intend to produce any kind ofimpact study on a potential 

increase in mortgage rates for borrowers if PCCRA is codified into law? 

As it reviews the comments regarding the proposal, including comments on the PCCRA, the 

Board is carefully considering the potential effects of the PCCRA, including on mortgage rates 

for borrowers, in detennining how to move forward with the rulemaking. This is consistent with 

the Board's rulemaking practice and the Board has incorporated economic impact information 

into its final rule notices where appropriate. 

I See 76 FR24113-24114 (April 29, 2011). 

2 SeeiQ. 

o