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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 THIRTEENTH CONGRESS 

FIRST SESSION 

FEBRUARY 27, 2013 

Printed for the use of the Committee on Financial Services 

Serial No. 113–3 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

JEB HENSARLING, Texas, Chairman 

GARY G. MILLER, California, Vice Chairman 

SPENCER BACHUS, Alabama, Chairman 

Emeritus 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

SHELLEY MOORE CAPITO, West Virginia 

SCOTT GARRETT, New Jersey 

RANDY NEUGEBAUER, Texas 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

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 

ROBERT HURT, Virginia 

MICHAEL G. GRIMM, New York 

STEVE STIVERS, Ohio 

STEPHEN LEE FINCHER, Tennessee 

MARLIN A. STUTZMAN, Indiana 

MICK MULVANEY, South Carolina 

RANDY HULTGREN, Illinois 

DENNIS A. ROSS, Florida 

ROBERT PITTENGER, North Carolina 

ANN WAGNER, Missouri 

ANDY BARR, Kentucky 

TOM COTTON, Arkansas 

MAXINE WATERS, California, Ranking 

Member 

CAROLYN B. MALONEY, New York 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

STEPHEN F. LYNCH, Massachusetts 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

GWEN MOORE, Wisconsin 

KEITH ELLISON, Minnesota 

ED PERLMUTTER, Colorado 

JAMES A. HIMES, Connecticut 

GARY C. PETERS, Michigan 

JOHN C. CARNEY, JR., Delaware 

TERRI A. SEWELL, Alabama 

BILL FOSTER, Illinois 

DANIEL T. KILDEE, Michigan 

PATRICK MURPHY, Florida 

JOHN K. DELANEY, Maryland 

KYRSTEN SINEMA, Arizona 

JOYCE BEATTY, Ohio 

DENNY HECK, Washington 

SHANNON MCGAHN, Staff Director 

JAMES H. CLINGER, Chief Counsel 

(III) 

C O N T E N T S 

Page 

Hearing held on: 

February 27, 2013 ............................................................................................ 1 

Appendix: 

February 27, 2013 ............................................................................................ 57 

WITNESSES 

WEDNESDAY, FEBRUARY 27, 2013 

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

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

APPENDIX 

Prepared statements: 

Ross, Hon. Dennis ............................................................................................ 58 

Bernanke, Hon. Ben S. ..................................................................................... 61 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

Bernanke, Hon. Ben S.: 

Monetary Policy Report to the Congress, dated February 26, 2013 ............. 71 

Written responses to questions submitted by Representative Bachus ........ 129 

Written responses to questions submitted by Representative Fitzpatrick .. 133 

Written responses to questions submitted by Representative Garrett ........ 135 

Written responses to questions submitted by Representative Maloney ...... 142 

Written responses to questions submitted by Representative Mulvaney .... 147 

Written responses to questions submitted by Representative Ross ............. 150 

Written responses to questions submitted by Representative Royce ........... 152 

Written responses to questions submitted by Representative Stivers ......... 162 

(1) 

MONETARY POLICY AND THE 

STATE OF THE ECONOMY 

Wednesday, February 27, 2013 

U.S. HOUSE OF REPRESENTATIVES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The committee met, pursuant to notice, at 10 a.m., in room 2128, 

Rayburn House Office Building, Hon. Jeb Hensarling [chairman of 

the committee] presiding. 

Members present: Representatives Hensarling, Miller, Bachus, 

Royce, Capito, Garrett, Neugebauer, McHenry, Campbell, 

Bachmann, Pearce, Posey, Fitzpatrick, Westmoreland, 

Luetkemeyer, Huizenga, Duffy, Hurt, Grimm, Stivers, Fincher, 

Stutzman, Mulvaney, Hultgren, Ross, Pittenger, Wagner, Barr, 

Cotton; Waters, Maloney, Velazquez, Watt, Sherman, Meeks, 

Capuano, Hinojosa, Clay, McCarthy of New York, Scott, Green, 

Cleaver, Moore, Ellison, Perlmutter, Himes, Peters, Carney, Sewell, 

Foster, Kildee, Murphy, Delaney, Sinema, Beatty, and Heck. 

Chairman HENSARLING. The committee will come to order. 

Without objection, the Chair is authorized to declare a recess of 

the committee at any time. 

The Chair now recognizes himself for an opening statement. 

We are clearly in the midst of the slowest and weakest recovery 

in the post-war era, notwithstanding what we have observed to be 

the largest fiscal and monetary stimulus in our Nation’s history. 

Although one quarter does not make a trend, having negative economic growth in the last quarter was not good news. Otherwise, we 

appear to be mired in 11⁄2 to 2 percent economic growth, when 3 

percent is the norm and, clearly, 4 percent is the potential. This 

translates into millions of lost jobs and hundreds of billions of dollars of lost revenue to the Treasury. 

But beyond the numbers, we have to look at the people. I look 

at my constituents, I listen to them. They are concerned about how 

they are going to fill up their pickup trucks, and how they are 

going to afford groceries. Their health care premiums have gone 

up. They are insecure in their paychecks. They are not getting 

ahead. 

So as we welcome Chairman Bernanke back for his semiannual 

Humphrey-Hawkins testimony before our committee, many wonder, where do we find the road forward? 

After quadrupling its balance sheet, engaging in unprecedented 

mortgage-backed security asset purchases, and creating an extended negative real interest rate environment, there is a growing 

consensus among economists that the Federal Reserve’s road has 

2 

led us to the monetary ‘‘Outer Limits.’’ And if one remembers that 

classic science fiction television program, typically the episodes did 

not end well. They did not have happy endings, and I fear this may 

prove true for the current Federal Reserve policy. 

For diminishing marginal benefits, the Federal Reserve’s unconventional strategy creates considerable risk. If the balance sheet is 

not unwound at the right time and at the right pace, we could be 

looking at another deep recession, soaring inflation, or skyrocketing 

interest rates, all of which could make us look longingly and nostalgically upon the Jimmy Carter era of stagflation. 

All central bankers are familiar with Walter Bagehot’s dictum of 

the central bank’s lender-of-last-resort function, ‘‘Lend freely at a 

high rate on good collateral.’’ Many of us believe the Fed has gone 

way beyond that. The extraordinary measures of 2008 appear to 

have become the ordinary measures of 2013. 

Walter Bagehot also said, ‘‘What impresses men is not mind, but 

the result of mind.’’ And although the Federal Reserve contains 

many impressive minds and many impressive public servants, currently millions of unemployed and underemployed Americans are 

not impressed with the results. I believe that is because today the 

economic challenges of our nature are essentially fiscal in nature, 

not monetary. They cannot be solved by the Fed. 

The reasons that the Nation is mired in the slowest, weakest recovery in the post-war era are simple. Under this President, we 

have seen a 53 percent increase in job-harming Federal tape and 

regulations. They tend to fall into two categories: those that create 

uncertainty; and those that create certain harm. Under this President, we have witnessed a spending spree, including the $1 trillion 

failed stimulus that has grown government from 20 percent of GDP 

to 24 percent. Under this President, a long-threatened $1.6 trillion 

tax increase has just been imposed upon small businesses and 

many working families. And under this President, more debt has 

been created in 4 years on a nominal basis than in our Nation’s 

first 200 years, now weighing in at approximately $136,000 per 

household. 

So let’s examine the tale of two recoveries. The 1981–1982 recession was deeper in terms of GDP contraction, and unemployment 

was higher, and the recession was similar in its financial nature. 

And, in this case, the economy faced a dramatic contractionary 

monetary policy that pushed interest rates over 20 percent. Yet, because President Reagan ushered in a pro-growth tax relief, established budget discipline, relieved much of the burden of foolish red 

tape, and promoted and celebrated free-market capitalism, we witnessed one of the quickest and most powerful recoveries in the Nation’s history. President Obama and the U.S. Senate could certainly 

profit from this example. Again, today, our challenges are primarily 

fiscal in nature, not monetary. 

Finally, as I close, since I know both the Chairman and many 

Members will speak to the pending sequester, I have no doubt that 

our President is quite capable of designing the meager budget savings represented in the sequester in such a way as to maximize 

pain to the American people. But as a matter of fact, even after the 

sequester, government outlays will be $15 billion more next year, 

and 30 percent greater than the year President Obama was first 

3 

elected. Meanwhile, the national debt clock to my right and to my 

left continues to spin out of control, threatening our national security, our economic recovery, and our children’s future. 

I now recognize the ranking member for 5 minutes for an opening statement. 

Ms. WATERS. Thank you very much, Mr. Chairman. I am very 

appreciative for the fact that you are holding this hearing. 

But before I begin my statement today, I would like to take a 

moment to recognize Mr. Dave Smith, the chief economist of the 

Democratic staff of the Financial Services Committee, who will be 

retiring at the end of this week. Dave has been an invaluable resource to the members of this committee, and we will certainly 

miss having his counsel and guidance. We thank him for his dedication and extensive service and wish him all the best in his future 

endeavors. 

Mr. Dave Smith. 

[applause] 

Chairman HENSARLING. Can you please restart the clock for the 

ranking member? 

Ms. WATERS. And, with that, I am very pleased to welcome 

Chairman Bernanke before the committee to present his report on 

the conduct of monetary policy and the state of the economy, as required twice a year by the Humphrey-Hawkins Act. 

First, I would like to commend Chairman Bernanke for his leadership and bold efforts, in cooperation with the Federal Open Market Committee (FOMC), to foster the conditions that stimulate 

lending, economic activity, and private sector job creation. 

While some have expressed concerns about the potential risk involved in the Fed’s aggressive quantitative easing programs, I sincerely believe our central bank’s actions have provided critical support for our Nation’s economic recovery. In fact, the Fed’s intervention may be one of the few actions protecting that recovery from 

some of my colleagues’ ongoing pursuit of retractionary fiscal policies. 

As we sit here today, yet another manufactured fiscal crisis 

looms due to sequestration’s automatic spending cuts that are 

scheduled to take effect in just 2 days. And despite those who wish 

to downplay the impact of sequestration, the costs are real. The 

CBO estimates that 750,000 jobs are at stake in 2013. The Bipartisan Policy Center projects the loss of at least a million jobs over 

the next 2 years. And a recent George Mason University study put 

the number at 2.14 million jobs, over 950,000 of which would be 

attributable to losses by small businesses. 

It is my hope that both Republicans and Democrats can come together to construct a more balanced approach to addressing the 

deficit while protecting our Nation’s ongoing recovery from the 

worst financial crisis since the Great Depression. 

With that in mind, I wanted to use this opportunity to note a 

GAO report released last month which outlined the enormous cost 

of the financial crisis to the U.S. economy. The GAO found that the 

financial crisis’ impact on economic output could be as much as $13 

trillion, and, in addition, the amount of home equity wealth lost by 

U.S. homeowners reached $9.1 trillion. 

4 

And this is precisely why I believe it is imperative that we fully 

implement the regulatory reforms within the Wall Street Reform 

Act in order to ensure that we never again experience a crisis like 

the one that occurred in 2008. 

I look forward to Chairman Bernanke’s insight on all of these 

matters and, in particular, his perspective on how the automatic 

spending cuts scheduled to take effect this week will impact our 

Nation’s recovery and economic growth. 

Mr. Bernanke, members of this committee, and Chairman 

Hensarling, I would like you to know that I take these HumphreyHawkins reports that are done twice a year seriously. As many of 

you know, Gus Hawkins was my predecessor. And when I ran for 

office, I ran for office at the time that Gus Hawkins was getting 

involved with this dual mandate that is the essence of the Humphrey-Hawkins Act. 

We know that Mr. Hawkins was concerned about jobs and he 

was concerned about monetary policy. And because of his concern, 

he worked very hard with Senator Hubert Humphrey to make sure 

that jobs and monetary policy played an important role in the deliberations and the debate and the discussions that go on in the 

Congress of the United States of America. 

And so, as we are faced with sequestration, we must understand 

the negative impact that sequestration and these cuts will have on 

jobs and the economy. And your being here today, Mr. Bernanke, 

is extremely important, because no one knows better than you 

about the impact of sequestration and what it will do to our jobs 

and our jobs potential in this country and, of course, the monetary 

policy that you have so creatively and so expertly guided to help 

get us back on the road to growth. And without what you are 

doing, we would not have maintained growth, slow as it may be, 

without what you have done and your leadership. I thank you very 

much. 

And I yield back the balance of my time. 

Chairman HENSARLING. The Chair now recognizes the chairman 

of the Monetary Policy and Trade Subcommittee, the gentleman 

from California, Mr. Campbell, for 3 minutes. 

Mr. CAMPBELL. Thank you, Mr. Chairman. 

And welcome, Chairman Bernanke. 

You said yesterday, and you will say today, that you believe the 

short-term benefits of the current loose monetary policy exceed the 

longer-term risks. We know from the release of the Federal Open 

Market Committee minutes last week that there is some dissension 

within the FOMC on that viewpoint. I am going to join in the chorus of dissension about that viewpoint. And I would like to just 

quickly detail seven risks that I believe exist which, together, are 

exceeding what I believe are now the meager benefits of the current monetary policy. 

First of all, there are bubbles out there. I would argue that there 

is one in high-yield bonds, perhaps in farmland, and certainly in 

the Federal budget. 

Second, where there are not bubbles, there are distortions, as 

people are having a difficulty pricing risk, and there are distortions 

in the economy. When these bubbles and distortions unwind, those 

are going to create problems. 

5 

Third, I hear all the time that the major investment and business strategy now is, don’t fight the Fed. That is not a real business strategy. That is not looking out at long-term vision. That is 

not making decisions on where you think markets will go. That is 

simply following the directive of an agency that unfortunately has 

too great a footprint, in my opinion, in the economy today. 

Fourth, all of this is actually not injecting certainty but, in my 

view, injecting uncertainty into decision-making in the economy 

today. 

Fifth, savers and retirees are being forced into riskier assets in 

the search for some sort of yield. When this unwinds, that is going 

to be a problem for our savers and retirees. We all in economics 

learned early on, as you get older, take less risk. But now what we 

find is as people are getting older, they are having to violate that 

principle, and in search of some kind of yield, are taking much, 

much greater risks, which could be a problem in the future. 

Sixth, for every 1 percent that the interest rates on Treasury 

bills go up, it will add $1 billion of deficit to the Federal budget. 

And, seventh, the Federal Reserve itself has risks now, with the 

large balance sheet and the large number of holdings that the Federal Reserve has. 

In this Member’s opinion, Mr. Chairman, we have gone too far 

in the monetary policy and the monetary easing, and it is, in this 

Member’s opinion, time to pull back. 

I yield back. 

Chairman HENSARLING. The gentleman yields back. 

The Chair now recognizes the ranking member of the Monetary 

Policy and Trade Subcommittee, the gentleman from Missouri, Mr. 

Clay, for 3 minutes. 

Mr. CLAY. Thank you, Chairman Hensarling, for holding this 

hearing on monetary policy and the state of the economy. 

Also, thank you, Chairman Bernanke, for appearing today. 

The Full Employment and Balanced Growth Act of 1978, better 

known as the Humphrey-Hawkins Act, set four benchmarks for the 

economy: full employment; growth in production; price stability; 

and the balance of trade and budget. To monitor progress toward 

these goals, the Full Employment and Balanced Growth Act of 

1978 mandated that the Board of Governors of the Federal Reserve 

System present semiannual reports to Congress on the state of the 

U.S. economy and the Nation’s financial welfare. 

Humphrey-Hawkins charges the Federal Reserve with a dual 

mandate: maintaining stable prices; and full employment. Currently, the unemployment rate is 7.9 percent, down from 8.3 percent a year ago. Still, millions in this country would like to work 

but cannot find work. Consumer price inflation has increased as 

prices of consumer food and energy have increased from the pace 

seen in previous months. Recent price increases in retail gasoline 

have increased the cost of food. 

All of these factors play a very important role in getting America 

back to economic growth and prosperity. And I look forward to 

Chairman Bernanke’s comments. 

Mr. Chairman, I yield back. 

Chairman HENSARLING. The gentleman yields back. 

6 

At this time, we will welcome our distinguished witness, one of 

Washington’s ablest public servants, Ben Bernanke, the Chairman 

of the Board of Governors of the Federal Reserve System. And, as 

the phrase goes, he needs no further introduction. 

Chairman Bernanke, you will be recognized for 5 minutes to give 

an oral presentation of your written testimony. Without objection, 

your written statement will be made a part of the record. 

Once you have finished presenting, each Member of the committee will have 5 minutes within which to ask any or all questions. I wish to inform all Members that Chairman Bernanke will 

be allowed to exit at 1 p.m., and this chairman will ride the gavel 

accordingly. So if you ask a question with 10 seconds to go on the 

clock, do not expect an answer. 

On the Republican side, I wish to inform our Members that, 

should you not be able to ask questions of the Chairman today, you 

will receive priority at the Chairman’s next appearance before our 

committee. 

Chairman Bernanke, at this time, please proceed. 

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

SYSTEM 

Mr. BERNANKE. Thank you, Mr. Chairman, Ranking Member Waters, and members of the committee. I am pleased to present the 

Federal Reserve’s semiannual monetary policy report. I will begin 

with a short summary of current economic conditions and then discuss aspects of monetary and fiscal policy. 

Since I last reported to this committee in mid-2012, economic activity in the United States has continued at a moderate, if somewhat uneven, pace. In particular, real GDP is estimated to have 

risen at an annual rate of about 3 percent in the third quarter but 

to have been essentially flat in the fourth quarter. 

The pause in real GDP growth last quarter does not appear to 

reflect a stalling out of the recovery. Rather, economic activity was 

temporarily restrained by weather-related disruptions and by transitory declines in a few volatile categories of spending, even as demand by U.S. households and businesses continued to expand. 

Available information suggests that economic growth has picked up 

again this year. 

Consistent with the moderate pace of economic growth, conditions in the labor market have been improving gradually. Since 

July, non-farm payroll employment has increased by 175,000 jobs 

per month on average and the unemployment rate has declined 

three-tenths of a percentage point to 7.9 percent over the same period. Cumulatively, private sector payrolls have now grown by 

about 6.1 million jobs since their low point in early 2010 and the 

unemployment rate has fallen a bit more than 2 percentage points 

since its cyclical peak in late 2009. 

Despite these gains, however, the job market remains generally 

weak, with the unemployment rate well above its longer-run normal level. About 4.7 million of the unemployed have been without 

a job for 6 months or more, and millions more would like full-time 

employment but are able to find only part-time work. 

7 

High unemployment has substantial costs, including not only the 

hardship faced by the unemployed and their families but also the 

harm done to the vitality and productive potential of our economy 

as a whole. Lengthy periods of unemployment and underemployment can erode workers’ skills and attachment to the labor force 

or prevent young people from gaining skills and experience in the 

first place, developments that could significantly reduce their productivity and earnings in the longer term. The loss of output and 

earnings associated with high unemployment also reduces government revenue and increases spending, thereby leading to larger 

deficits and debts. 

The recent increase in gasoline prices, which reflects both higher 

crude oil prices and wider refining margins, is hitting family budgets. However, overall inflation remains low. Over the second half 

of 2012, the price index for personal consumption expenditures rose 

at an annual rate of 11⁄2 percent, similar to the rate of increase in 

the first half of the year. Measures of longer-term inflation expectations have remained in the narrow ranges seen over the past several years. Against this backdrop, the FOMC anticipates that inflation over the medium term will likely run at or below its 2 percent 

objective. 

With unemployment well above normal levels and inflation subdued, progress toward the Federal Reserve’s mandated objectives of 

maximum employment and price stability has required a highly accommodative monetary policy. Under normal circumstances, policy 

accommodation would be provided through reductions in the 

FOMC’s target for the Federal funds rate, the interest rate on overnight loans between banks. However, as this rate has been close 

to zero since December 2008, the Federal Reserve has had to use 

alternative policy tools. 

These alternative tools have fallen into two categories. The first 

is forward guidance regarding the FOMC’s anticipated path for the 

Federal funds rate. 

At its December 2012 meeting, the FOMC provided more explicit 

guidance on how it expects the policy rate to respond to economic 

developments. Specifically, the December post-meeting statement 

indicated that the current exceptionally low range for the Federal 

funds rates ‘‘will be appropriate as long as the unemployment rate 

remains above 61⁄2 percent, inflation between 1 and 2 years ahead 

is projected to be no more than half a percentage point above the 

Committee’s 2 percent longer-run goal, and longer-term inflation 

expectations continue to be well-anchored.’’ 

An advantage of the new formulation relative to the previous 

date-based guidance is that it allows market participants and the 

public to update their monetary policy expectations more accurately in response to new information about the economic outlook. 

The new guidance also serves to underscore the Committee’s intention to maintain accommodation as long as needed to promote a 

stronger economic recovery with stable prices. 

The second type of nontraditional policy tool employed by the 

FOMC is large-scale purchases of longer-term securities, which, 

like our forward guidance, are intended to support economic growth 

by putting downward pressure on longer-term interest rates. The 

8 

Federal Reserve has engaged in several rounds of such purchases 

since 2008. 

Last September, the FOMC announced that it would purchase agency mortgage-backed securities at a pace of $40 billion per 

month. And in December, the Committee stated that, in addition, 

beginning in January, it would purchase longer-term Treasury securities at an initial pace of $45 billion per month. 

These additional purchases of longer-term Treasury securities replace the purchases we were conducting under our now-completed 

Maturity Extension Program, which lengthened the maturity of our 

securities portfolio without increasing its size. The FOMC has indicated that it will continue purchases until it observes a substantial 

improvement in the outlook for the labor market in a context of 

price stability. 

The Committee also stated that in determining the size, pace, 

and composition of its asset purchases, it will take appropriate account of their likely efficacy and costs. In other words, as with all 

of its policy decisions, the Committee continues to assess its program of asset purchases within a cost-benefit framework. 

In the current economic environment, the benefits of asset purchases and of policy accommodation more generally are clear. Monetary policy is providing important support to the recovery while 

keeping inflation close to the FOMC’s 2 percent objective. Notably, 

keeping longer-term interest rates low has helped spark recovery 

in the housing market and led to increased sales and production 

of automobiles and other durable goods. By raising employment 

and household wealth—for example, through higher home prices— 

these developments have, in turn, supported consumer sentiment 

and spending. 

Highly accommodative monetary policy also has several potential 

costs and risks, which the Committee is monitoring closely. For example, if further expansion of the Federal Reserve’s balance sheet 

were to undermine public confidence in our ability to exit smoothly 

from our accommodative policies at the appropriate time, inflation 

expectations could rise, putting the FOMC’s price stability objective 

at risk. 

However, the Committee remains confident that it has the tools 

necessary to tighten monetary policy when the time comes to do so. 

As I noted, inflation is currently subdued and inflation expectations 

appear well-anchored. Neither the FOMC nor private forecasters 

are projecting the development of significant inflation pressures. 

Another potential cost that the Committee takes very seriously 

is the possibility that very low interest rates, if maintained for a 

considerable time, could impair financial stability. For example, 

portfolio managers dissatisfied with low returns may reach for 

yield by taking on more credit risk, duration risk, or leverage. On 

the other hand, some risk-taking, such as when an entrepreneur 

takes out a loan to start a new business or an existing firm expands capacity, is a necessary element of a healthy economic recovery. 

Moreover, although accommodative monetary policies may increase certain types of risk-taking, in the present circumstances 

they also serve in some ways to reduce risk in the system, most 

importantly by strengthening the overall economy, but also by enVerDate Nov 24 2008 16:58 Aug 02, 2013 Jkt 080869 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 K:\DOCS\80869.TXT TERRI
9 

couraging firms to rely more on longer-term funding and by reducing debt service costs for households and businesses. 

In any case, the Federal Reserve is responding actively to financial stability concerns through substantially expanded monitoring 

of emerging risks in the financial system, an approach to the supervision of financial firms that takes a more systemic perspective, 

and the ongoing implementation of reforms to make the financial 

system more transparent and resilient. 

Although a long period of low rates could encourage excessive 

risk-taking, and continued close attention to such developments is 

certainly warranted, to this point we do not see the potential cost 

of the increased risk-taking in some financial markets as outweighing the benefits of promoting a stronger economic recovery 

and more rapid job creation. 

Another aspect of the Federal Reserve’s policies that has been 

discussed is their implications for the Federal budget. The Federal 

Reserve earns substantial interest on the assets it holds in its portfolio, and other than the amount needed to fund our cost of operations, all net income is remitted to the Treasury. With the expansion of the Federal Reserve’s balance sheet, yearly remittances 

have roughly tripled in recent years, with payments to the Treasury totaling approximately $290 billion between 2009 and 2012. 

However, if the economy continues to strengthen, as we anticipate, and policy accommodation is accordingly reduced, these remittances will likely decline in coming years. Federal Reserve analysis shows that remittances to the Treasury could be quite low for 

a time in some scenarios, particularly if interest rates were to rise 

quickly. 

However, even in such scenarios, it is highly likely that average 

annual remittances over the period affected by the Federal Reserve’s purchases will remain higher than the pre-crisis norm, perhaps substantially so. Moreover, to the extent that monetary policy 

promotes growth and job creation, the resulting reduction in the 

Federal deficit would dwarf any variation in the Federal Reserve’s 

remittances to the Treasury. 

Mr. Chairman, I have a couple more pages on fiscal policy. Will 

you allow me to complete it, or should I stop? 

Chairman HENSARLING. You can proceed, Mr. Chairman. 

Mr. BERNANKE. Thank you, Mr. Chairman. 

Although monetary policy is working to promote a more robust 

recovery, it cannot carry the entire burden of ensuring a speedier 

return to economic health. The economy’s performance, both over 

the near term and in the longer run, will depend importantly on 

the course of fiscal policy. The challenge for the Congress and the 

Administration is to put the Federal budget on a sustainable longrun path that promotes economic growth and stability without unnecessarily impeding the current recovery. 

Significant progress has been made recently toward reducing the 

Federal budget deficit over the next few years. The projections released earlier this month by the CBO indicate that under current 

law, the Federal deficit will narrow from 7 percent of GDP last 

year to 21⁄2 percent in Fiscal Year 2015. As a result, the Federal 

debt held by the public, including that held by the Federal Reserve, 

10 

is projected to remain roughly 75 percent of GDP through much of 

the current decade. 

However, a substantial portion of the recent progress in lowering 

the deficit has been concentrated in near-term budget changes, 

which, taken together, could create a significant headwind for the 

economic recovery. The CBO estimates that deficit-reduction policies in current law will slow the pace of real GDP growth by about 

11⁄2 percentage points this year relative to what it would have been 

otherwise. 

A significant portion of this effect is related to the automatic 

spending sequestration that is scheduled to begin on March 1st, 

which, according to the CBO’s estimates, will contribute about sixtenths of a percentage point to the fiscal drag on economic growth 

this year. 

Given the still moderate underlying pace of economic growth, 

this additional near-term burden on the recovery is significant. 

Moreover, besides having adverse effects on jobs and income, a 

slower recovery would lead to less actual deficit reduction in the 

short run for any given set of fiscal actions. 

At the same time, and despite progress in reducing near-term 

budget deficits, the difficult process of addressing longer-term fiscal 

imbalances has only begun. Indeed, the CBO projects that the Federal deficit and debt as a percentage of GDP will begin rising again 

in the latter half of this decade, reflecting in large part the aging 

of the population and fast-rising health care costs. 

To promote economic growth in the longer term, and to preserve 

economic and financial stability, fiscal policymakers will have to 

put the Federal budget on a sustainable long-run path that first 

stabilizes the ratio of Federal debt to GDP and, given the current 

elevated level of debt, eventually places that ratio on a downward 

trajectory. 

Between 1960 and the onset of the financial crisis, Federal debt 

averaged less than 40 percent of GDP. This relatively low level of 

debt provided the Nation much-needed flexibility to meet the economic challenges of the past few years. Replenishing this fiscal capacity will give future Congresses and Administrations greater 

scope to deal with unforeseen events. 

To address both the near- and longer-term issues, the Congress 

and the Administration should consider replacing the sharp, frontloaded spending cuts required by the sequestration with policies 

that reduce the Federal deficit more gradually in the near term but 

more substantially in the longer run. Such an approach could lessen the near-term fiscal headwinds facing the recovery while more 

effectively addressing the longer-term imbalances in the Federal 

budget. 

The sizes of deficits and debt matter, of course, but not all tax 

and spending programs are created equal with respect to their effects on the economy. To the greatest extent possible, in their efforts to achieve sound public finances, fiscal policymakers should 

not lose sight of the need for Federal tax and spending policies that 

increase incentives to work and save, encourage investment and 

workforce skills, advance private capital formation, promote research and development, and provide necessary and productive 

public infrastructure. 

11 

Although economic growth alone cannot eliminate Federal budget 

imbalances in either the short or longer term, a more rapidly expanding economic pie will ease the difficult choices we face. 

Thank you for your indulgence, Mr. Chairman. 

[The prepared statement of Chairman Bernanke can be found on 

page 61 of the appendix.] 

Chairman HENSARLING. Thank you, Mr. Chairman. 

And the Chair will now recognize himself for 5 minutes for questions. 

Chairman Bernanke, I have both privately and publicly complimented you and the Fed for much of what you did in 2008, but, 

as you heard in my opening statement, I have a great fear that the 

extraordinary has become ordinary and, indeed, we need to examine these policies in, as you put it, a cost-benefit framework. So, 

briefly, I want to inquire about the risks, the benefits, and the cost. 

In your testimony, you said, ‘‘The Committee remains confident 

that it has the tools necessary to tighten monetary policy when the 

time comes to do so.’’ But, Mr. Chairman, I think you know that 

other predictions have not proven valid. In May of 2006, you 

seemed to be confident that we were witnessing ‘‘an orderly decline 

in the housing market,’’ and in 2007 you predicted ‘‘a soft landing 

for the economy,’’ neither of which happened. The Fed has been 

fairly off on its GDP projections, and as of 2 months ago, you stated, ‘‘Well, I think it is fair to say that we have overestimated the 

pace of growth.’’ 

So, Chairman Bernanke, I guess I recall Casey Stengel’s quote, 

‘‘Never make predictions, especially about the future.’’ I assume 

you will admit to being human and being fallible? 

Mr. BERNANKE. Yes, sir. 

Chairman HENSARLING. So that causes some of us to question 

how much confidence we should have. 

And as the gentleman from California, Mr. Campbell, pointed 

out, it is not just members of this committee, but apparently the 

voices of doubt and dissent within the Fed are growing more vocal. 

Jeffrey Lacker, President of the Richmond Fed: ‘‘I think that further monetary stimulus is unlikely to materially increase the pace 

of economic expansion and that these actions will test the limits of 

our credibility.’’ 

Bloomberg has reported of Charles Plosser, Philadelphia Fed 

President: ‘‘Plosser said he favored halting additional bond purchases because their benefits are pretty meager and there are lots 

of risk.’’ 

Closer to home, Richard Fisher, President of the Dallas Fed: ‘‘I 

will be asking myself, what good would it do to buy more mortgagebacked securities or more treasuries when we have so much money 

sitting on the sidelines and yet have no sense of direction for the 

future of the Federal Government’s tax and spending policy? How 

could additional monetary policy be stimulative?’’ 

I clearly believe you disagree with these Fed Presidents; is that 

correct? 

Mr. BERNANKE. Yes, sir. 

Chairman HENSARLING. Let’s examine the benefits of your current policy. Again, we know we are in a slow and weak recovery. 

Here is the question I have, Mr. Chairman. 

12 

According to Fed data, banks are sitting on $1.6 trillion in excess 

reserves, and in the latest quarter for which I have data, the third 

quarter of 2012, non-financial corporations are sitting on $1.7 trillion in liquid assets. So, arguably, that is over $3 trillion of capital 

sitting on the sidelines. I believe I have this right, at least for the 

last data I have on, I believe, QE2: 80 percent of that QE ended 

up as excess reserves. 

So, given as much capital is sitting on the sidelines and since we 

are essentially in a zero to negative real interest rate environment, 

why do you believe that further quantitative easing is somehow 

going to cause entrepreneurs and job creators to put all this capital 

to work? 

Mr. BERNANKE. Thank you, Mr. Chairman. 

First, on the disagreements on the committee, we have our debates more or less in public, as you know. And I hope you would 

take some comfort from the fact that a wide range of views and 

points of view are represented on the committee. And we— 

Chairman HENSARLING. I do take solace, and I hope you listen 

to them carefully. 

Mr. BERNANKE. And we do discuss all these issues. Of course, the 

significant majority of the committee is supportive of the policies 

that we are taking. 

You are absolutely also right that predicting the future is always 

dangerous. But we are not talking here about a forecast of the future. What we are talking about are the tools that we have to unwind the balance sheet. And we have a variety of different tools, 

including not just selling assets, but raising the interest rate we 

pay on excess reserves and the use of other draining tools, which, 

based on the experience of other central banks, would be effective 

in allowing us to unwind that policy. 

Of course, doing it at the exact right moment is always difficult, 

but— 

Chairman HENSARLING. Chairman, I am about out of time. I am 

going to attempt to set a good example here. I want to ask one last 

question, but you can submit the answer in writing. 

You mentioned earlier that—or as I understand it from data or 

reports from the Fed—you will cease remitting profits to the U.S. 

Treasury and that, under your own analysis, the size of deferred 

assets—I am always curious how a loss is a deferred asset—could 

peak at $120 billion, but other economists say it is closer to $372 

billion of taxpayer money that could exacerbate the debt. 

So, in writing, I would like for you to respond whether or not, indeed, the debt could be exacerbated by $372 billion under a 

worst-case scenario. 

At this time, I will recognize the ranking member for 5 minutes. 

Ms. WATERS. Thank you very much, Mr. Chairman. 

Again, Mr. Bernanke, I would like to thank you for further explaining and educating this committee on quantitative easing, the 

policy that you have provided leadership on. 

And I would like to make sure that the members of this committee understand that this discussion about all of this dissent is 

overblown. As I look at the voting on this action, it appears that 

you, Mr. Bernanke—William C. Dudley, James Bullard, Elizabeth 

Duke, Charles L. Evans, Jerome H. Powell, Sarah Bloom Raskin, 

13 

Eric Rosengren, Jeremy C. Stein, Daniel K. Tarullo, and Janet L. 

Yellen all voted to support you and the policies. There was only one 

person dissenting, and that was Esther George. 

So it seems to me you have strong support for the actions that 

you are taking and the leadership that you are giving. And I am 

very appreciative for that. 

I am surprised at myself for the confidence and support that I 

am showing, because you know I have disagreed with you in the 

past on a number of things. But I also find myself a little bit surprised that I am focused a lot on what happened with a recent research note that was released last Friday by the Bank of America’s 

chief economist, Ethan Harris, where he warned that harsh budget 

cuts due to start taking effect this week would hammer the economy, potentially dragging the country back down into a recession. 

Mr. Harris wrote that he expects this painful shot of austerity to 

slow GDP growth to just 1 percent in the second quarter, with job 

growth averaging less than 100,000 per month for those 3 months. 

We also know that many Republican and Democratic State Governors are demanding immediate action to stop the automatic 

spending cuts, expressing concerns that sequestration would force 

their State economies back into a recession. 

So, while you have explained to us monetary policy that you are 

providing this leadership on and while you have given us great information today about what you feel would happen with this economy if we did not stimulate it, somewhat in the way that you are 

doing, I want to ask you, can you offer any insight or more insight 

into what the potential impact would be to our economy’s recovery 

if the sequester were to take place as scheduled on March 1st? 

And can you elaborate on why you believe it is more important 

to focus, as you have said today, on deficit reduction over the long 

term rather than blunt austerity measures in the short term? I 

would like to hear more about this. 

Mr. BERNANKE. Yes, ma’am. I cited in my testimony just the 

numbers from the Congressional Budget Office, which suggest that 

fiscal measures will reduce growth this year by 1.5 percentage 

points, which is very significant. 

If you look at the path of the deficit projected by the CBO, you 

see that for the next few years, progress has been made, and the 

debt-to-GDP ratio, in particular, doesn’t look like it is going to be 

rising for the next few years. Where the problems arise which are 

the most serious are further out, when our aging society, rising 

health care costs, and so on, together with other costs, begin to 

bite. 

My suggestion for your consideration is to align the timing of 

your fiscal consolidation better with the problem. That is, to do 

somewhat less in the very near term when it will have the greatest 

impact on growth and jobs and where the Federal Reserve doesn’t 

have any scope to offset it, and instead to focus on the longer term 

where the real problems, I think, still remain. 

Ms. WATERS. So, you are not against cuts and you are not saying 

that we should not be involved in making cuts where we can make 

them. But what you are talking about is the level and the amount 

of the cuts that perhaps are being made which will slow down the 

growth in the economy. 

14 

And you think that if we concentrate more on job development 

and stimulating the economy, that we should take a long-term approach to the cuts. Is that basically what you are saying? 

Mr. BERNANKE. I am very much in favor of getting our fiscal 

house in order, but I think it is a long-run issue and I would be 

supportive of a less front-loaded set of measures. 

Ms. WATERS. I think it is important to get that on the record because I have heard some discussion about your statement, even as 

it was made yesterday, and I think some people were confused and 

thought you were saying we shouldn’t make any cuts. I think you 

are very clear about what you are proposing. And I thank you very 

much. 

And I yield back the balance of my time. 

Mr. BERNANKE. Thank you. 

Chairman HENSARLING. The Chair now recognizes the gentleman 

from California, Mr. Campbell, for 5 minutes. 

Mr. CAMPBELL. Thank you, Mr. Chairman. 

And, unlike the ranking member, I have generally agreed with 

what you have said in the past, but now we diverge. So, it is funny 

how that happens. 

In the January 2013 FOMC meeting minutes which were just released, it reads, in part, ‘‘A number of participants stated that an 

ongoing evaluation of the efficacy, costs, and risks of asset purchases might well lead the committee to taper or end its purchases 

before it judged that a substantial improvement in the outlook for 

the labor market had occurred.’’ 

If these voices are right and the unemployment does not drop 

significantly or below your target and inflation does not rise above 

your target, at what point do you decide to wind this down, call it 

quits, and try something else? 

Mr. BERNANKE. As I said in my remarks, we have a cost-benefit 

framework, and we are going to be looking at both sides of that 

equation. 

We will be looking at benefits, trying to assess whether we are 

getting traction, whether the economy is benefiting from these policy moves, whether we are seeing a stronger economy, particularly 

in the labor market. On the cost side, we will be looking at inflation concerns and financial stability concerns that you mentioned 

in your opening remarks, Congressman. 

They are perhaps less important than the first two, but the remittances issue and perhaps some market functioning issues. We 

will be looking at the whole set of these concerns and trying to assess whether those costs are sufficient to induce a less aggressive 

policy or whether there are alternative measures—say, regulatory, 

supervisory, or other measures—that could more effectively or in a 

more precise way address those issues. 

So that will continue. We plan to have a continual discussion and 

review of both the costs and the benefits and try to make sure that 

we are taking the right steps, given those costs and benefits. 

Mr. CAMPBELL. Is it safe to say that if the unemployment rate 

does not drop further as a result of these asset purchases, that is 

an indication that the benefits are declining? 

Mr. BERNANKE. If we see no progress for an extended period, 

which I don’t expect because we have already seen some progress, 

15 

then I think we will want to discuss the efficacy side of the equation, is it working. 

My sense at this point—and it is very early—is that we are getting some traction in the housing market, which has shown some 

strength in the last few days, some of the data most recently. In 

automobiles and other durable goods, to some extent in investment, 

to some extent perhaps in commercial real estate, we have seen 

some signs of improvement. But we want to keep evaluating and 

seeing if, in fact, we are getting benefits from this policy. 

Mr. CAMPBELL. There seems to be, towards that end, the benefits, a lot of evidence out there that the benefits of the low interest 

rate and quantitative easing are accruing primarily to the Federal 

Government, foreign governments, and large banks. Now, I think, 

clearly, those are not the entities that need to or that are doing the 

lion’s share of hiring or need to do the majority of hiring. 

But do you agree with that view? And how do you rationalize the 

QE, given that view out there that is who is benefiting primarily 

from— 

Mr. BERNANKE. I completely disagree with that. This is very 

much focused at the average American citizen. Our estimates are 

that we have helped create many private sector jobs. Government 

jobs, of course, have been declining quite significantly. People are 

able to buy houses at very low mortgage rates or refinance at low 

mortgage rates. People are able to get car loans at low rates. Their 

house values have gone up so that they feel more financially secure. So in a lot of dimensions we have, I think, benefited Main 

Street, and that is certainly our objective. 

From the other sectors, we often get complaints. For example, 

banks have complained about the low interest rates squeezing their 

interest margin. I think the main benefits are those that are affecting the broader economy, and that is the broad group of Americans. 

Mr. CAMPBELL. In the final 30 seconds, there is some concern 

that the agency MBS market is losing liquidity because I believe 

you are on pace to own, the Fed is, 20 percent of outstanding agency MBS and you are purchasing 40 percent of new issuance and 

that you are the market, there is no other market. Is that a concern? 

Mr. BERNANKE. The market functioning, the Treasury and MBS 

market functioning, is something we do I wouldn’t say every day 

but every hour, because we are heavily engaged in those markets, 

obviously. And, to this point, we don’t see any significant problems 

with those markets. But if we do see problems, obviously we will 

react to that. But, to this point, we haven’t seen anything significant. 

Mr. CAMPBELL. I yield back. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Missouri, Mr. 

Clay, for 5 minutes. 

Mr. CLAY. Thank you, Mr. Chairman. 

Chairman Bernanke, how would you describe the current condition of the U.S. housing market? Have we bounced back? And do 

you predict that we will witness significant employment gains if 

and when the housing market rebounds? 

16 

Mr. BERNANKE. As you know, the housing market took a tremendous blow: about 30 percent or more declines in prices; a massive 

decline in construction and sales. And that was a major factor, obviously, in the severity of the recession. 

As the chairman reminds me, it is difficult to make predictions, 

but the evidence thus far is that the housing market has hit the 

bottom and is recovering. We have seen rising prices over the last 

year or so. We have seen some significant increases in starts and 

sales. Foreclosures are still too high, but they are coming down. 

The number of people underwater in their mortgages is coming 

down. 

So we are still far from where we would like to be, but the evidence is that the housing market is strengthening and that low 

mortgage rates are one reason for that strengthening. 

And that should put people to work in several ways. It will put 

construction workers back to work, obviously, and people who work 

in factories that build appliances or other things that are related 

to housing. But, in addition, the increase in house prices and the 

increase in general economic activity should benefit other industries as well. 

Mr. CLAY. Thank you for that response. 

Another area that seems to be ahead of pace of our economy is 

health care and the spiraling costs of health care. Do you foresee 

prices stabilizing there, or will it just continue to spiral out of control and hit consumers the hardest? 

Mr. BERNANKE. This is a critically important issue because one 

of the main sources of our long-term budget problems is the fact 

that health care costs have gone up a lot faster than other costs 

over the last 40 years or so. 

Recently, in the last 4 or 5 years, health care costs have actually 

gone up somewhat more slowly. Part of that may be due to the recession and the fact that fewer people are able to afford or seek 

care. 

So I think it remains to be seen whether this relative decline in 

the pace of increase of health care costs is going to persist or not. 

If it does, it will be very good news, not only for Americans who 

are trying to afford health care, but also for the Federal budget. 

But I think there remains a lot to be done in the health care area 

to improve incentives, to improve quality, and to improve access. 

Mr. CLAY. Thank you for that response. And I am sure we could 

have an entire hearing on just the cost of health care and the longterm and short-term goals for that area. 

Currently, the unemployment rate, according to the Labor Department, is 7.9 percent. What can the Federal Reserve and Congress do to put Americans back to work? I heard you say in your 

testimony that we should continue investing in job training and retraining. Any other suggestions? 

Mr. BERNANKE. On the fiscal side, I mentioned, first, the notion 

of taking a longer-run perspective on addressing our fiscal sustainability issues to avoid some of the adverse effects in the near term 

of very sharp cuts and job losses. 

And the second point, as you noted, is that I think everyone 

would agree on both sides of the aisle that the money we do spend 

and the taxes we do collect should be done in the best way possible. 

17 

We should be thinking about each program and is it achieving the 

objectives that we set for it and is it creating a better trained workforce, is it creating a more productive economy, is it creating a 

more fair and equitable and efficient Tax Code. Those are the kinds 

of issues that need to be addressed, as well as simply the total 

spending and revenue numbers. 

Mr. CLAY. And, as you are aware, the Dodd-Frank Wall Street 

Reform and Consumer Protection Act required that Offices of Minority and Women Inclusion (OMWI) be established within agencies regulating financial institutions. 

What action has the Federal Reserve System taken to meet these 

requirements? 

Mr. BERNANKE. We have followed everything required by the 

law. We have established an OMWI in the Fed and in each of the 

12 Federal Reserve Banks. We are pursuing the supplier diversity 

and other requirements of the law. And we are working collectively, as we have been told to do, with the other agencies to develop some criteria for assessment of diversity practices in regulated institutions. 

Mr. CLAY. Thank you, Mr. Chairman. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the vice chairman of the committee, 

the gentleman from California, Mr. Miller, for 5 minutes. 

Mr. MILLER. Thank you, Mr. Chairman. 

It is good to have you here, Chairman Bernanke. 

I know you care about unemployment and inflation. You have expressed that in your statements over and over. And I know you 

care about the economy. But I am having some concerns with some 

of the regulations being proposed by the Fed right now. 

You did state that the housing market is recovering, and I agree 

with that, but it is very fragile, in my opinion. Some of the new 

housing regulations are very concerning. The QM was meant to 

protect consumers, but, as finalized, it really prevents creditworthy 

consumers from getting a mortgage, in my opinion. A recent study 

by CoreLogic says that 48 percent of the 2010 mortgage originations would be eligible under QM. And perhaps some of those 

shouldn’t have been made, but that is a scary number. 

And I am concerned about the Federal Reserve’s proposed rule 

on ability to repay as defined as qualified mortgage. Any loan that 

does not meet this requirement basically will not be made in the 

marketplace. And a recent study by CoreLogic says that is a huge 

problem. 

On QRM, it is meant to make sure that lenders have skin in the 

game. But, as drafted, the field will be so small that I am not sure 

there is going to be a field by the time you get through with it. 

We sent a letter to you—I think 208 Members signed—complaining about the 20 percent down. If QRM is too narrow, I believe first-time home buyers will be driven out of the marketplace, 

which will cause another dip in the housing market. And Congress 

intended for mortgage insurance to be a qualifying factor in QRM. 

Could you please speak to that? 

Mr. BERNANKE. Certainly. As you know, we couldn’t finalize the 

QRM rules until the QM rules were completed because QRM can 

be no broader than QM. 

18 

We have heard comments from Congress. We are considering 

them very carefully. I would say that the idea that QRM should be 

as broad or nearly as broad as QM is very much on the table. And 

we appreciate the concerns of Congress that these criteria should 

not so constraining as to prevent creditworthy borrowers from obtaining a mortgage. 

Mr. MILLER. But you have lenders right now who are really keeping capital out of the marketplace because they don’t know what 

is going to happen. At some point in time, we need to be very 

proactive in getting some form of a message out as to what the situation will be. Because it is really creating havoc in the industry, 

in my opinion. Do you agree with that? 

Mr. BERNANKE. The uncertainty is certainly a problem, and it is 

one of the reasons why we haven’t seen a resurgence of the privatelabel MBS market. But, again, now that QM is done, the agencies 

can work quickly to finalize the QRM rule. 

Mr. MILLER. Okay. 

Another concern I have is bank capital standards are one issue, 

and insurance companies are completely different. The U.S. insurance companies hold about $5 trillion in assets today. And the 

Fed’s proposed rule on capital standards based on Basel III, the 

rule is designed by bank regulators, which makes sense for banks, 

but they also apply to insurance companies. Insurance and banking 

are very different, as I know you agree. Strong capital standards 

are important, but they must be appropriate for the business model 

to which they apply. 

Will the Feds perform a qualitative impact study specific to insurance before you finalize the standard rules, like the QIS you do 

for banks? 

Mr. BERNANKE. We are discussing the feasibility of such a study. 

And we recognize that there are important differences between 

banks and insurance companies. At the same time, of course, we 

have statutory constraints, the Collins Amendment, for example, 

that say that a certain amount of capital is necessary. But we have 

also heard from Congress about this insurance-banking distinction, 

and we are looking at it very seriously. 

We have been consulting, I should say, with the State insurance 

regulators, with the Federal Insurance Office, with the industry, 

and with a lot of other stakeholders to make sure we understand 

these issues. 

Mr. MILLER. There is a tremendous amount of havoc in that industry today because of what they don’t know. And, again, I think 

some action is pretty necessary in the immediate rather than in 

the long term on that, wouldn’t you agree? 

Mr. BERNANKE. Certainly. We want to get these rules out as 

quickly as possible. But on the other hand, as you point out, we 

need to make sure that they are appropriately set for the insurance 

business model, and that will take some time to study and understand. 

Mr. MILLER. Okay. 

The last question you might not have time to answer, but you 

announced the QE3 last September. You said you would keep buying assets until there was substantial improvement in the labor 

market. I think you addressed it earlier. You said that mortgageVerDate Nov 24 2008 16:58 Aug 02, 2013 Jkt 080869 PO 00000 Frm 00022 Fmt 6633 Sfmt 6633 K:\DOCS\80869.TXT TERRI
19 

backed security purchases will boost economy by driving down 

long-term interest rates. 

But looking at the impact that QE3 has had on the mortgage 

market rates, we are at historically low levels right now. I am not 

seeing much change, but maybe that was the intent. But the Fed’s 

balance sheet, like you said, had $3 trillion of holdings. 

Do you think that the mortgage interest rates are where they 

should be to meet the objectives of QE3, or do you think they need 

to be lower? 

Mr. BERNANKE. I think they are low enough that they are providing a lot of assistance, a lot of help to homeowners. 

The low mortgage rates are a product not just of our latest program but of all the previous programs and our policies regarding 

short-term rates and the like. One of the paradoxes is that the best 

way to get interest rates up is to have low interest rates, because 

that promotes a stronger growing economy and that causes interest 

rates to rise. In some ways, the fact that interest rates have gone 

up a bit, and it happens on the real, not the inflation side, is actually indicative of a stronger economy, which, again, suggests that 

maybe this is having some benefit. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentlelady from New York, Mrs. 

Maloney, for 5 minutes. 

Mrs. MALONEY. Thank you. Welcome, Chairman Bernanke. I believe this country owes you a debt of gratitude. Thank you for your 

leadership during one of the worst recessions in my lifetime. You 

took unprecedented measures which took our economy that was in 

a total freefall, and we are now on the road to recovery; however, 

I am deeply concerned about housing. 

As we all know, the housing market and the foreclosure crisis 

continues to be a major impediment to our economic growth. Some 

economists have estimated that housing and its related industries 

are 25 percent of our economy. So until we get this straight, we are 

not going to really fully and strongly recover, and that is why I 

want to spend my time this morning asking you about the Federal 

Reserve’s role in the independent foreclosure review process. As 

you may know, I have written you and the OCC 3 letters over the 

past 2 months, and I would like permission if I may, Mr. Chairman, to place them in the record. 

Chairman HENSARLING. Without objection, it is so ordered. 

Mrs. MALONEY. I know the deadline that I gave your office was 

March 1st, but since we are only 48 hours away from that, I 

thought I would take this opportunity to get some clarity. 

First of all, how is it that in the past 18 months, over $1.5 billion 

has been given to independent consultants, but absolutely nothing 

has been given to the up to 4 million injured homeowners, some of 

whom have lost their homes unjustly during this 18-month review 

process? We have $9.3 billion in aid that is not helping any distressed homeowners. 

I have been told by parties involved in the process that there was 

an agreement between all the institutions that no aid would be 

given to help injured homeowners until all the institutions were 

ready and able to make payments. 

20 

So first, who gave this order that no money would be paid to borrowers, to the people who were injured, while at the same time 

nearly $2 billion was generated in fees to private contractors? 

Mr. BERNANKE. We agreed with you that plan was not working. 

As you know, the way it was set up was that the private consultants would evaluate the files and determine how much damages 

were warranted. They had not made all that much progress, frankly, and it was a very expensive cost per file evaluated, and we were 

on a track—and we take responsibility for this—where the money 

going to the consultants would be some multiple of the money 

going to the borrowers. So as you know, we have changed the process to a much quicker, more streamlined process, which is going to 

cut out the consultants and which will have checks going out to 

borrowers very, very shortly, within weeks. 

Mrs. MALONEY. Don’t you think that it would have been a better 

process if you had, and certainly more effective, to compensate borrowers whose harm was found and documented rather than wait 

for the entire process to be completed or to make this adjustment 

at midterm? We can put a person on the Moon. Why in the world 

can’t we solve this? This whole foreclosure process is really dragging down the whole housing industry, because no one knows what 

to do. 

If you are going to send out checks soon, which I am glad to 

hear, how did you make the determination of who should receive 

these checks, and where are they going and what was the criteria? 

And what are you going to do to clean up this backlog and take 

this whole problem off and help the homeowners, which was the intention of the settlement to begin with, yet 2 years later no one has 

been helped? 

Mr. BERNANKE. No. You are absolutely right. 

Mrs. MALONEY. I can’t tell you the stories I have heard of people 

who have lost their homes, and no one even knows who owns their 

home; it just sits there vacant. We have to get this straightened 

out. Can you just give me some timeframe and how we are going 

to fix this? 

Mr. BERNANKE. Yes. We have agreements with most of the 

servicers, which will be made public shortly, because they are being 

incorporated into the enforcement orders under which they are operating. As you know, we have about a $9 billion agreement, all of 

which will be reflected either in cash payments or in mortgage relief to borrowers, none going to consultants. That is very much 

under way. 

My guess as to why the payments hadn’t occurred until now is 

that it was just such a slow, ungainly process, but I will get you 

more information on that. On the criteria, we are going to have to 

use some shortcuts, because we don’t have a full analysis. 

Mrs. MALONEY. Do you think we should fall back— 

Chairman HENSARLING. The time of the gentlelady has expired. 

And the Chair now recognizes the chairman emeritus, the gentleman from Alabama, Mr. Bachus, for 5 minutes. 

Mr. BACHUS. Thank you, Chairman Bernanke. Chairman 

Bernanke, I am going to ask you to reconsider the Fed’s Proposed 

Rule 165 as it relates to foreign banking organizations which don’t 

have a U.S. bank, but here in the United States only operate a 

21 

broker-dealer. And let me give you four reasons. I don’t want to engage you in a debate at this time, but first, to have that approach 

is different from any other regulatory regime that would apply to 

U.S. broker-dealers of our American companies. So you are using 

a different approach, but their broker-dealer doesn’t have to be 

placed in that. 

Second, it is discriminatory, in my mind, because the securities 

broker-dealer of the foreign banking organization could have a 

higher capital standard because of the standard imposed on the intermediate bank holding company. 

We also have the longstanding principle of, I guess, national 

treatment where you don’t have disparate treatment, and I think 

this violates that. 

Also, you have an expressed statutory provision that prohibits 

the Federal Reserve from overriding the capital requirements of a 

functionally regulated subsidiary of a bank holding company such 

as a broker-dealer subsidy whose capital requirements are established by the SEC. So to me, it would violate that. 

Now, I would also tell you to look at Section 165(b)(3) of DoddFrank, which says that in prescribing standards, the Fed should 

also take into account whether a foreign bank owns an insured 

bank as well as whether it has another primary regulator. 

So I would ask you, and I would think that you consulted with 

the SEC, that you consulted with the foreign regulators, but I just 

got back from Germany, and this was brought up on three different 

occasions by both government officials and European banks as to 

why are you treating us differently. I know you have extended the 

comment period of this rule to April 20th, but I would like to just 

exchange a series of letters and point out this in more detail. 

Mr. BERNANKE. Thank you for calling that to my attention. 

Mr. BACHUS. Thank you. And it is—there are over 100 foreign 

banks that are operating here that would be under—or could be 

under a different capital requirement than our local banks, and I 

think that could cause problems with our international regulators. 

And I am sure you have heard from some of them. 

Let me say to the membership, both Republicans and Democrats, 

and particularly those who have come here just in the past 5 years, 

Chairman Bernanke told us today exactly what he has told us for 

the last 5 years, and that is he has told us to focus on long-term 

structural changes to our mandatory spending programs, most of 

which are entitlements. And that ought to be our focus, and he said 

that today. He said that it will have a beneficial effect, a long-term 

beneficial effect, it will not retard economic recovery. 

Now, what have we done as opposed to what he has—and I have 

asked that same question to you for 5 years. You have always responded, focus on long-term structural changes, because of the demographics. 

What have we done? Last year, we had some success. This Congress doesn’t get the benefit of—we had $2.5 trillion worth of cuts 

and revenue measures that reduced our debt for the next 10 years 

$2.5 trillion, and most people are saying we have about another 

trillion, $1.5 trillion to go. 

And I will say this. I know your hand is on the clock. This sequestration was a bipartisan mistake by Members of both parties. 

22 

We were told it wouldn’t go into effect. That is a gamble we will 

lose on March 1st. 

What we need to do is substitute these short-term changes for 

maybe going up on the retirement age 2 months or some means 

testing. This is not rocket science. And I say to the President and 

to this Congress, quit fiddling around, get to work, and let us come 

up with $85 trillion worth of long-term structural changes. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentlelady from New York, Ms. 

Velazquez, for 5 minutes. 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. Chairman Bernanke, 

will you please help me out? Did you state in your testimony that 

we need to make structural changes to entitlement programs or did 

you say that front-loaded spending cuts required by the sequestration with policies that reduce the Federal deficit more gradually in 

the near term, but more substantially in the longer run? 

Mr. BERNANKE. Yes. Congresswoman, I said that you need to be 

looking at the long run— 

Ms. VELAZQUEZ. Okay. 

Mr. BERNANKE. —which is where the problems are most serious. 

Ms. VELAZQUEZ. Mr. Chairman, as it has been stated, the housing sector has continued to see improvement with increased construction activity and higher home prices. As you know, the rate 

of economic recovery relies heavily on a robust housing market. 

And I am interested in hearing from you what will be the impact 

or the effect to the economy if Fannie Mae, Freddie Mac, and the 

FHA were scaled back or abolished, as some policymakers have 

proposed? 

Mr. BERNANKE. Currently, Fannie, Freddie, and FHA are pretty 

much the whole mortgage market. Other than portfolio lending by 

banks, there is not much in the way of alternative securitization. 

So simply shutting them down without doing anything else would 

no doubt restrict credit quite considerably, but I think we all 

agree— 

Ms. VELAZQUEZ. And it would have an impact on job creation? 

Mr. BERNANKE. Yes. I think we all agree that over the longer 

run, we need to come to a more acceptable set of institutions, but 

right now, of course, they are providing most of the support for the 

mortgage market. 

Ms. VELAZQUEZ. Thank you. Mr. Chairman, past iterations of the 

Basel allowed exemptions for community banks from the complex 

capital rules imposed on large multinational banks. Was that approach considered for this round of Basel? 

Mr. BERNANKE. I am not sure I quite understood. The— 

Ms. VELAZQUEZ. In Basel I and Basel II, small banks, community 

banks were exempted from those rules. Now in Basel III, they were 

not. They were not the ones that created the economic crisis. 

Mr. BERNANKE. Of course. The community banks have always 

been subject to capital rules, of course. They are exempt from 

many, many of the more complex rules which apply to large internationally active banks, and that will continue to be the case. And 

I am sure you are alluding to concerns that small banks have 

raised about— 

Ms. VELAZQUEZ. Right. 

23 

Mr. BERNANKE. —the recent proposed rule. We have heard that 

from Members on both sides of the aisle as well as from the industry and other stakeholders, and we are looking at that very carefully. 

Ms. VELAZQUEZ. I am concerned about that, because when we 

look at the survey of loan officers, it still shows that access to capital for small businesses continues to hinder economic growth, and 

community banks are the one that lend to small businesses. I am 

concerned to know whether or not someone was advocating for community banks when it comes to imposing regulations on Basel III. 

Mr. BERNANKE. We are looking carefully both at community 

banks and at small business lending, and we recognize the importance of those two institutions. 

Ms. VELAZQUEZ. Thank you. 

Mr. CAMPBELL [presiding]. Does the gentlelady yield back her 

time? 

Ms. VELAZQUEZ. I do. 

Mr. CAMPBELL. The gentlelady yields back her time. 

Now, the chairwoman of the Financial Institutions and Consumer Credit Subcommittee, the gentlelady from West Virginia, 

Mrs. Capito, is recognized for 5 minutes. 

Mrs. CAPITO. Thank you, Mr. Chairman. And thank you, Chairman Bernanke, for being with us today. I would like to add my 

voice of concern to the previous questioner, Ms. Velazquez, on the 

issue of the Basel III and the effect it is having on and could have 

on our community banks. We had a hearing several months ago, 

and it was pretty unanimous in the hearing from all voices that 

there is a serious concern on what impact this could have on lending for small businesses and the ability really for community banks 

to survive and flourish. I know you have already answered that 

question, so I appreciate the fact that you are keeping that in mind 

as we move forward on this regulatory issue. 

You talked about the sequester and talked about how you would 

prefer it to go at a more gradual pace rather than the more dramatic pace that it appears that it could be going at this point, because of the influence of jobs. 

I have a great idea. I live in an energy State. If we would unleash the power of this country to really have a full and flourishing 

energy economy, both including in my State, coal and natural gas, 

but Keystone Pipeline and others, we would have thousands of people, more people working, we would have energy independence, we 

could have availability of natural gas as a transportation fuel. It 

fuels our chemical industry and our power generation. 

So I would like, from your perspective, and I am very frustrated 

by the regulatory issues and, I think the inability of the Administration to move forward in full-out energy independent policies that 

I think could create many, many jobs. 

Where do you see energy as a part of the whole national economy, energy independence and the job effects that an energy economy can bring? 

Mr. BERNANKE. Energy has been one of the bright spots in our 

economy in the last couple of years. We have seen tremendous increases of production of natural gas, increasing oil production. 

There is talk of coming close to energy independence over the next 

24 

few years. That has created a lot of jobs and has been a positive 

factor in many parts of our country. 

Of course, there are always environmental issues which arise, 

and I am frankly not qualified— 

Mrs. CAPITO. Right. 

Mr. BERNANKE. —to give you a sense of how those balance out 

against each other. I hope that solutions can be found which will 

preserve the environment and also allow for the development of our 

resources, because as you say, it creates jobs and reduces our vulnerability to foreign energy sources. 

Mrs. CAPITO. You mentioned gas prices as a reason that is hurting our economy in general, and certainly all of our constituents 

are feeling this very much. I think energy economy, there again, 

could answer in a small way and maybe a large way the issue of 

gasoline as we move towards energy independence. So, I would like 

to hear you talk about the energy economy more as part of our 

broader economy, because I think you said it is a bright spot; let’s 

feature it as a way for us to pull ourselves out of a slower recovery. 

So I would encourage you to do that. 

My other question is on seniors. Many of us are in that sandwich 

generation trying to help our parents, and our parents are doing 

a pretty good job trying to help themselves, but they are relying on 

their good planning and investments, if they have been lucky 

enough to invest. The dividend and interest availabilities to them 

are crushing our seniors as they see their health care costs go up. 

And some of the policies that you have put forward, I think, and 

that the Fed has caused concern for those of us who are concerned 

about seniors who don’t have the ability to get another job—that 

is played out for them. 

What can I tell my seniors back home that is going to give them 

some optimism that they are going to be able to rely on that good 

planning that they had to carry them through to their senior 

years? 

Mr. BERNANKE. I would say first that savers have many hats. 

They may own fixed-income instruments like bonds, but they also 

may own stocks or a house or a business. All of those other assets 

benefit when the economy strengthens. 

Mrs. CAPITO. Right. 

Mr. BERNANKE. And those values have gone up. The stock market has roughly doubled, as you know, in the past 2 years. So from 

an investment perspective, there are alternatives. 

I think more importantly, though, you are not going to get strong 

returns in an economy that is fundamentally weak. The best way 

to get sustainable high returns to savers is to get the economy back 

to running on all cylinders. And it is somewhat paradoxical, but in 

some ways the best way to get interest rates up is not to raise 

them too quickly, because by keeping rates low now, we can help 

the economy get stronger, we can create more jobs, we can create 

more momentum in the economy. That is the way to get a sustainable higher set of interest rates. 

It is very striking that if you look at every other industrial country around the world, interest rates are about exactly where they 

are here, and that says something about the fundamentals, which 

are very weak in most of these industrial countries. And until we 

25 

can get greater forward momentum, we are not going to be able to 

see sustainable higher returns. 

Mrs. CAPITO. All right. Thank you very much. 

Mr. CAMPBELL. The gentlelady’s time has expired. 

The gentleman from California, Mr. Sherman, is recognized for 

5 minutes. 

Mr. SHERMAN. Chairman Bernanke, I want to thank you for the 

wisdom to recognize that our country needs an expansionary monetary policy, the fortitude to stick with it when apparently you have 

some critics, and the creativity to go beyond your traditional tools 

in carrying out that policy. 

I listened carefully to my California Republican colleagues. I 

want to associate myself with Mr. Miller in his comments about a 

QRM definition that isn’t too far from the QM definition. I heard 

Mr. Campbell criticize the Fed because he hears people saying that 

you shouldn’t fight the Fed and it is hard to price risk. 

I am pretty old. I have seen your predecessors carry out just 

about every kind of Fed policy I can imagine. Everybody is always 

muttering, don’t fight the Fed. And the only time they ever say it 

is easy to price risk is when they are wrong. So the mutterings that 

the gentleman from California hears are fully consistent with not 

only your monetary policy, but every other monetary policy you 

could imagine. 

And Ms. Velazquez points out how important Fannie Mae and 

Freddie Mac are, and FHA. We heard testimony here from Moody’s 

Analytics that if FHA hadn’t been there, we would have seen another 25 percent decline in home prices. In my view, if that had 

happened, America would look somewhere between Greece and 

Thunderdome. So it is fortunate that we have those institutions. 

We have a lot of capital on the sidelines, as the gentleman from 

California pointed out. Investment needs funds, but it also needs 

people willing to take a risk. Some criticize that as reaching for 

yield, but if everybody is only willing to invest in investments 

where the appropriate yield is 2 or 3 percent, we are not going to 

have any small business lending. I have never seen a small business with a 98 percent chance of success. We have banks out there, 

they have a lot of capital, they face a lot of pressure to invest at 

2 and 3 and 4 percent. 

I am told by bankers that if they invest in something that has, 

say, an 8 percent likelihood of default, they don’t face an 8 percent 

reserve or a 10 percent reserve or a 12 percent reserve, they get 

100 percent charge to capital. 

What can the Fed do so that loans that are a bit—they are not 

just the 2 or 3 percent loans, are valued conservatively and the 

portfolio is valued conservatively, but not with a penalty valuation? 

Mr. BERNANKE. I would like to continue that discussion with you. 

The reserving practices are mostly tied to actual problems with 

loans, not with loans that are made that may be risky, ex ante. 

And, in fact, one of the issues that has been an issue for a while 

is can banks put aside reserves against general risk of credit loss 

as opposed to losses in specific loans. 

So we have generally been supportive actually of banks doing 

more reserving so they would have some reserves available against 

26 

losses not yet seen or understood, but I think maybe we need to 

have a further conversation about this. 

Mr. SHERMAN. I look forward to that. Timing is everything in a 

lot of fields. This is a pretty ideological city right now, and an ideologue either believes that it is always the right time to cut taxes, 

always the right time to cut spending, or always the right time to 

increase spending, or always the right time to increase taxes, or always the right time to do whatever their ideology requires. 

In your opening statement, you point out that the Fed is adopting a different approach. You actually have different policies for 

different business conditions and your line is 61⁄2 percent unemployment, along with some other factors. 

The national debt is a growing cancer, but this is an economy 

that suffered a heart attack in 2008. And you don’t administer 

chemotherapy while a patient is still in the cardiac ICU. 

Would the markets have confidence in Congress, and it is hard 

to think of whether they would ever have confidence in Congress, 

if we have statutory provisions which, like your policies, had a trigger and moved toward a more contractionary fiscal policy with, say, 

a 61⁄2 percent unemployment rate? 

Chairman HENSARLING. The time of the gentleman has expired, 

and the Chairman can answer the question in writing. 

The Chair now recognizes the gentleman from New Jersey, Mr. 

Garrett, for 5 minutes. 

Mr. GARRETT. I thank the chairman and I thank Chairman 

Bernanke. Let me just try to run through in 5 minutes three areas, 

what you talked about on remittances, what you talked about as 

far as some of the positive results, and if we have time, some of 

the effects of the somewhat current loose monetary policy on an 

international state. 

So on remittances, I think you already said that the remittances 

are here, but they are potentially to go down in the future. If you 

look at the consolidated balance sheet of the Federal Reserve, we 

have capital of less than $55 billion, and assets of more than $3 

trillion, so that means that all you need is about a 1 quarter of 1 

percent increase in the interest rates, and you basically wipe out 

what you basically have right now, which is a 55 to 1 ratio, and 

you wipe that out. 

So what is your prediction actually on that going forward with 

regard to interest rates wiping that ratio out and the effect on remittances to Congress? Can you be more specific on the numbers? 

Mr. BERNANKE. Certainly. So currently, as I have said, we have 

in the last 4 years, remitted $290 billion, we currently have more 

than $200 billion of unrealized capital gains on our balance sheet. 

The capital issue is irrelevant. We have additional funding behind 

the capital. We have $3 trillion of liabilities which are not callable 

liabilities, like cash, for example. 

Mr. GARRETT. I guess I would just ask you if you could follow up 

on detail on that, because that is not the way I understand it, but 

I would ask you to put that in writing. 

Mr. BERNANKE. The main reality here is that if interest rates 

rise very quickly, then there may be a period where we don’t pay 

any remittances at all to the Treasury. That is the actual outcome. 

That is important. 

27 

Under most, and I would say virtually all scenarios, we will be 

sending remittances to the Treasury substantially higher than the 

norms established before the crisis. 

Mr. GARRETT. Since my time is limited, what we are looking at here is around $90 billion in remittances if—you said we could actually see that almost go down to eliminate it. Right now, we are 

trying to do a sequester at $85 billion. So it sort of puts us in perspective as to what the effect could be as far as your policies there. 

With regard to the positive indications that you have indicated, 

you said the stock market and the housing market have gone up 

because of your monetary policy, but previously you said that the 

Fed’s monetary policy actions earlier this decade, in 2003–2005, did 

not contribute to the housing bubble in the United States. So which 

is it? Is monetary policy by the Fed not a cause of inflationary 

prices of housing, as you have said in the past, or is it a cause of 

inflating prices of housing? Can you have it both ways? 

Mr. BERNANKE. Yes. 

Mr. GARRETT. You can? 

Mr. BERNANKE. Yes, we can have it both ways, because they are 

different phenomena. 

The mortgage rate is a quantitative thing. House prices are going 

up a reasonable amount, given the strengthening of the housing 

market, given the strengthening of the economy, given where mortgage rates are. But mortgage rates in the early part of this last 

decade were around 6 percent. That can’t explain why house prices 

rose as much as they did. Maybe it was a small contribution, but 

it certainly can’t explain the big run-up and then decline. 

Mr. GARRETT. But now it is. 

So the other area you indicated why we should say your policies 

are working in a cost-benefit analysis is the stock market. I am 

sure you are familiar with Milton Friedman’s work that says that 

people only really consume off of their permanent income, which 

basically means that you don’t consume increased consumption because your stocks have gone up in the marketplace. 

And to that point, I know Mrs. Capito asked the question as to 

what seniors should do in this situation, and you said, take it out 

of some fixed assets and put it into the stock market. Heaven forbid that my 90-year-old mother would take her money out of fixed 

markets and put it in the stock market. I think that is probably 

the worst advice that is out there. And when you consider that a 

1 percent increase in the stock market only has infinitesimal, 

maybe a 100 percent increase in GDP, I really don’t understand: 

first, how you can give that advice; or second, how you can suggest 

that an increase in the stock market is a positive indicator of your 

work in a cost-benefit analysis to the rest of the economy. 

Mr. BERNANKE. I was not giving financial advice. I apologize if 

I gave that impression. I was just saying— 

Mr. GARRETT. But she was asking you— 

Mr. BERNANKE. —that generally— 

Mr. GARRETT. She was asking you the question, what should you 

be doing to benefit the seniors, what should we say to the seniors. 

And your comments were— 

Mr. BERNANKE. What I was saying was that the economy will get 

stronger because of good policies and that in turn will cause rates 

28 

to rise in a sustainable way. If we were to raise rates prematurely, 

we would kill the recovery and rates would come down and we 

would have a long-term situation with very low rates. 

Mr. GARRETT. But wouldn’t you have provided for the certainty 

in the marketplace so you could have more price transparency? 

Earlier, you said that some risk-taking in the market is appropriate. That was one of your opening comments. Sure, risk-taking 

is appropriate, but it is appropriate when there is actual price discovery. When you have a market that is distorted, as it is right 

now by the Fed’s monetary policy, you really don’t have true price 

discovery. And so when you do risk-taking now, it is based upon 

not really knowing what the appropriate value is of land prices, equity markets prices, so risk-taking now is worse than risk-taking 

is when the Fed’s actions do not distort the marketplace. If you 

would say—thank you. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from New York, Mr. 

Meeks, for 5 minutes. 

Mr. MEEKS. Thank you, Mr. Chairman. Chairman Bernanke, 

more of us thank you for all of your work and what you do with 

reference to our great country. 

In your opening statement, you talked a lot and you indicated 

about jobs, and I think that is the going subject matter. Everybody 

is concerned about jobs on both sides of the aisle, and the creation 

of jobs, yet we have had 35 straight months of private sector job 

growth, but we are continuing to have, as you said, high, and stubbornly high, unemployment rates. And as I look at it, with that 

steady growth, we have shed over 600,000 public sector jobs since 

the beginning of the financial crisis in late 2008. In fact, The Wall 

Street Journal estimated last year that the unemployment rate 

would be at least one full percentage point lower if we still had 

those jobs, those 600,000 jobs. 

So my question to you is, what strains have these massive public 

sector layoffs put on your ability to stabilize the employment sector, and what do you think we need to do in regards to that to replace those jobs? 

Mr. BERNANKE. Let me first say that I understand why States 

and localities in particular laid off a lot of workers, because their 

tax revenues went down, they had to balance their budgets, and 

that was the only option they had, but it is true that State and 

local governments, their retrenchment during the recovery and 

their layoffs were a headwind for the broader economic recovery. In 

fact, the fiscal retrenchment at the State and local level in this recovery has been much more severe than in virtually any other recovery. 

So the good news, I guess, and one of the reasons why I think 

we may have a somewhat stronger economy going forward is that 

State and local governments seem now to have stabilized their 

budgets, and as a result we don’t expect to see those ongoing layoffs to the extent that we have seen them in the past. 

But, yes, it is true that the contraction of State and local government budgets, together with more recent cuts in the Federal budget, has resulted in job loss certainly in those sectors and in the 

economy more broadly. 

29 

Mr. MEEKS. And sequestration as we see it right now on a Federal level could exacerbate that with— 

Mr. BERNANKE. I have cited the Congressional Budget Office, 

which I think has reasonable estimates, yes. 

Mr. MEEKS. Let me also go to a question, because you have been 

asked about banks and banks lending, and Alan Blinder had an op 

ed in The Wall Street Journal last year, if I recall, pointing out 

that in an effort to spur lending by banks, central banks in Europe 

are cutting their interest, cutting the interest they pay on excess 

reserves to zero. In fact, the Danish cut it to a negative 0.2 percent, 

meaning banks would have to pay the central bank to keep reserves with them. 

Now, this seems to me to be a powerful incentive to either lend 

or put money to work in the markets. So my question is, do you 

believe that this policy, if implemented here, would it benefit the 

U.S. economy? And if not, why not? 

Mr. BERNANKE. Banks are currently being paid on their reserves 

25 basis points, one-fourth of 1 percent. They are actually receiving 

less than that on net, because they also have to pay FDIC premiums on the deposits that they hold on the other side of their balance sheet, so they are receiving just a few basis point on their reserves. 

If we cut the interest on reserves, say, to zero or slightly negative, which is possible, it would have a very, very small effect in 

the right direction, but a very, very small effect on the incentives 

of banks to make loans. Basically, they are not finding as many 

loans as they would like to make when they are earning 8 basis 

points on their reserves. Would it help to get it down to zero? It 

is in the right direction, as I said, but one of the reasons that we 

have hesitated to do that is because it would also lower returns 

throughout the money markets in our economy and would create 

some problems in terms of the functioning of money markets, the 

Federal funds market, and other short-term cash markets. So it is 

not clear that the benefits in terms of more stimulus outweigh the 

costs in terms of market functioning. That being said, it has always 

been something that we have kept on the table and talked about 

periodically. 

Mr. MEEKS. So it is something that is still on the table and you 

are still talking about? Because I like movement in the right direction. 

Mr. BERNANKE. It is not a powerful tool, though, in any sense. 

Mr. MEEKS. I have 10 seconds left, I don’t think I am going to 

get my next question in, but the—because my next question was 

basically what you were told—told Senator— 

Chairman HENSARLING. No, no. The gentleman cannot get his 

next question in. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Texas, Mr. 

Neugebauer, for 5 minutes. 

Mr. NEUGEBAUER. Thank you, Mr. Chairman. And, Chairman 

Bernanke, thank you for being here this morning. Mr. Chairman, 

I want to walk through the proposed exit strategy that I think was 

put forward in June of 2011 and see if you foresee taking any different steps. I believe in that exit strategy you said we would begin 

to cease reinvesting payments of principal on security holdings, I 

30 

guess as they matured. The second part of that was raising the Fed 

funds rate while adjusting the interest rate on excess reserves and 

levels of reserves in the banking system to kind of bring those 

funds towards a targeted rate. And then I think the third part of 

that was selling off some of the Fed securities after the first increase in the target for the Federal funds rate. 

So according, though, to the most recent FOMC minutes released, a number of participants discussed the possibility of providing monetary accommodation by holding securities for a longer 

period of time than what was originally envisioned by the committee’s exit principles, either to supplement or to replace other asset 

purchases. This kind of suggests a deviation from the course put 

forward in 2011, and I would suspect there may be other changes 

that are being discussed from the June 20th exit strategy as well. 

So you have laid out this exit strategy, and now based on these 

subsequent conversations and discussions that are going on, how 

confident should investors and the business community be that this 

exit strategy will be the same 6 months from now or 3 years from 

now? And given the huge size of your balance sheet and the potential uncertainty that changes in this exit strategy could cause, are 

you concerned that we are creating some additional uncertainty in 

an already uncertain economy? 

Mr. BERNANKE. No, I don’t think so. We haven’t done a new review of the exit strategy yet. I think we will have to do that some 

time soon. I am pretty confident the basic outline that you just described would still be in force. 

The one thing we could do differently, as you pointed out, is hold 

some of the securities a little longer. We could even let them just 

run off. I just want to be clear that even if we don’t sell any securities, it doesn’t mean that our balance sheet is going to be large for 

many years. It just would be maybe an extra year. That is all it 

would take to get back down to a more normal size. 

So that is one issue, how long to hold the securities and whether 

to use that as a substitute, an alternative to asset purchases. I 

think that is something worth discussing, but I don’t see any radical shift in the way this is going to happen. 

And, again, as I said earlier, we are quite comfortable that we 

can exit in a way that is both smooth and in which we provide lots 

of information to markets in advance so they will know what is 

coming and be able to anticipate it. 

Mr. NEUGEBAUER. I thought it was kind of interesting when you 

said that we need to take a slower approach to deficit reduction 

and that the economy couldn’t withstand a major reduction in government spending. Don’t you find it a little disconcerting that we 

have let the government become so much of the economy that cutting our deficit so that we don’t mortgage the future of our children 

and grandchildren should be even a consideration in deficit reduction? 

Mr. BERNANKE. Government is an important part of every advanced economy now. And I am not by any means saying that we 

should not deal with the deficit problem. I am just saying we 

should take a longer-term perspective. 

Mr. NEUGEBAUER. When people talk about fiscal policy and monetary policy, you always say, I am in charge of monetary policy, not 

31 

fiscal policy, but Mr. Chairman, I almost find the Fed to be a deficit enabler in the environment that we are in right now. And the 

reason I would say that is the fact that last year, I think you transferred about $90 billion back to the Treasury. So basically, whatever securities that they yield, you buy down their yield to almost 

zero. You have put $90 billion additional money in the hands of the 

government, yet we still ran a $1.2 trillion deficit. So we are almost 

enabling the government to continue to spend, because we are allowing them to have this borrowing habit at a very cheap price because of the actions that you are taking at the Fed to buy those 

yields down. 

Chairman HENSARLING. The time of the gentleman has— 

Mr. NEUGEBAUER. You can follow up and answer in writing. 

Mr. BERNANKE. Okay. I will follow up. 

Chairman HENSARLING. If you can follow up in writing, please. 

The gentleman from Massachusetts, Mr. Capuano, is recognized 

for 5 minutes. 

Mr. CAPUANO. Thank you, Mr. Chairman. And thank you, Chairman Bernanke, for being here again. Mr. Chairman, I have read 

most of the 57-page report and I have read your 9 pages, and honestly every time any Fed Chairman has ever come before here, it 

is like I get a headache before, during, and afterwards. I love you 

dearly, but trying to parse all these things that everybody is saying 

is very difficult for average people, including me. 

And I guess I want to read one sentence from your testimony to 

make sure that I understand it correctly. This is from your testimony: ‘‘To address both the near and long-term issues, the Congress and the Administration should consider replacing the sharp 

front-loaded spending cuts required by the sequestration with policies that reduce the Federal deficit more gradually in the near 

term, but more substantially in the longer run.’’ 

I think I read this correctly, but would it be fair for me to paraphrase this to average people that the Chairman of the Federal Reserve thinks that sequestration is stupid? 

Mr. BERNANKE. I wish you wouldn’t do that. What I am saying— 

Mr. CAPUANO. But would it be fair? 

Mr. BERNANKE. What I am saying is that by a more gradual approach but with more cuts in the longer term achieves both objectives, not slowing the recovery by too much, but on the other hand 

addressing these long-term issues that Congressman— 

Mr. CAPUANO. Like I said, I am getting a headache again. From 

what I just heard, you said, again to paraphrase, not to quote, that 

you think sequestration is stupid. And I agree with you. Don’t 

worry. It is okay. Sequestration is going to get its fair share of attention today and this week and next week, but I want to focus on 

something that is a little bit more closely related to directly what 

the Fed does, and that is the too-big-to-fail. 

I was reading your testimony from yesterday, and the written 

testimony, and again I want to read your words as reported relative to too-big-to-fail on the subsidy, relative to the too-big-to-fail 

thing. And you say, the subsidy is coming because of market expectations that the government would bail out these firms if they 

failed, period. Those expectations are incorrect. 

That is a quote from you. Is that a fair— 

32 

Mr. BERNANKE. Yes. 

Mr. CAPUANO. Okay. So am I reading this correctly that you believe that at least through legislative purposes, that too-big-to-fail 

is just nonexistent anymore, not through the market, but through 

the law? 

Mr. BERNANKE. We don’t have—the tools that were used in 2008 

are gone now. What we have instead is the Orderly Liquidation 

Authority, which among other things would wipe out all the shareholders of the company being liquidated. 

Now, if we had a systemically large important firm fail tomorrow, it still could be very damaging to our economy. And we are 

working— 

Mr. CAPUANO. I understand. We could do something— 

Mr. BERNANKE. —working in that direction. 

Mr. CAPUANO. —but the law currently as drafted, after DoddFrank and after all of the things we have been through, today we 

do not have the tools that we used to implement too-big-to-fail as 

it was in 2008. 

Mr. BERNANKE. The tools that the Federal Reserve used are no 

longer available to us. 

Mr. CAPUANO. I am glad to hear that. And I also agree with you 

that regardless of what the law says, some people in the marketplace, especially some of my friends on the other side of the aisle, 

like to believe that it is still in existence. And I accept that, not 

as a legal point, but as a fact of reality. Some people think that 

the Moon is made of cheese, and that is fine. To them, that is real. 

So for some people, too-big-to-fail is still there, though there is no 

scientific or legal proof that it is. 

I guess what I am asking is, what do you suggest that we do to 

address that misconception of the market and the misconception of 

some of my own colleagues that too-big-to-fail is still here? Because 

I think we all agree that we don’t want it to be here, it is not here. 

How do we address that misconception to make it a reality? 

Mr. BERNANKE. Dodd-Frank as a strategy involves making big 

institutions internalize, take account of their systemic costs by 

tougher regulation, higher capital charges, and so on, the Orderly 

Liquidation Authority and strengthening the entire system. So 

there are steps that we are taking that are moving in that direction. I think the markets will come to see that these steps are effective. Of course, we can communicate it, we can say it, but— 

Mr. CAPUANO. But we have been saying it for years now, and 

some people refuse to believe it. Do you accept the general—and, 

again, not for the dollar, but there have been some studies that put 

the subsidy that—the alleged subsidy that is there for the too-bigto-fail that doesn’t exist anyway, but that market perception of a 

subsidy— 

Mr. BERNANKE. Yes. No. There still is some—I am sure there is 

still some— 

Mr. CAPUANO. And I accept that. 

Mr. BERNANKE. —market perception. It is declining, but we need 

to be working in the direction of eliminating it entirely. 

Mr. CAPUANO. And do you think that subsidy can be quantified 

in a reasonable way? 

33 

Mr. BERNANKE. With lots of assumptions and so on, you can compare what large banks pay in the market to what small banks pay, 

and that gives you some sense— 

Mr. CAPUANO. Be prepared to get a request from me later on to 

try to do that quantification. 

Mr. BERNANKE. Senator Warren cited some studies to me yesterday, so maybe— 

Mr. CAPUANO. Yes, but that is not your study. I want yours. 

Thank you. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from North Carolina, 

Mr. McHenry, for 5 minutes. 

Mr. MCHENRY. Thank you, Mr. Chairman. And, Chairman 

Bernanke, thank you for your service to our government, and to 

our people. 

To follow up on my colleague from Texas’ question about Fed policy masking the true cost of our fiscal profligacy, now, the question 

is, would the Fed buying 48 percent of U.S. debt for Fiscal Year 

2013 and with a zero or negative real interest rate, isn’t the Fed 

the great enabler of our debt? I understand Congress and the 

President make fiscal policy, but isn’t the Fed’s policy in essence 

masking the true cost of our debt? 

Mr. BERNANKE. If I can make three points. The first is that as 

a share of all the debt outstanding, the Fed’s ownership is actually 

lower today than it was before the crisis. We own about 15, 16 percent of all the debt outstanding. So those interest rates you see on 

the debt comes from actual market trading between private sector 

individuals. 

The second point is that, as I have emphasized today, there is 

a very long-term problem here. What is going to matter is the interest rate not today, but the interest rate 5 years from now, 10 

years from now, 15 years from now. Congress, I hope, has the foresight to see that interest rates will not be this low forever and, 

therefore, they should take that into account. 

And then, finally, I ask, what is the alternative? If we raised interest rates substantially just to make it harder for the Congress 

to borrow, if at the same time we do damage to the economy and 

lower revenues and make the deficit even worse, I don’t see how 

that is really helpful to our fiscal situation. So my hope is that 

Congress will recognize that interest rates will rise over time as 

our economy recovers and that this is a long-term proposition and 

they should take that into account in their decisions. 

Mr. MCHENRY. So in the short run, yes? 

Mr. BERNANKE. No. And, again, we only have about 15, 17 percent of the total debt outstanding. It is not the case that we are 

buying, all the debt being— 

Mr. MCHENRY. No, no. Just 48 percent this fiscal year. 

Mr. BERNANKE. Of the new debt— 

Mr. MCHENRY. Yes. 

Mr. BERNANKE. —but not on average. Again, 85 percent of it is 

circulating in private hands. 

Mr. MCHENRY. Okay. Now, to go to a separate point, Bloomberg 

reported that at your recent meeting of the Treasury Borrowing 

Advisory Committee, which is a group of senior bankers and invesVerDate Nov 24 2008 16:58 Aug 02, 2013 Jkt 080869 PO 00000 Frm 00037 Fmt 6633 Sfmt 6633 K:\DOCS\80869.TXT TERRI
34 

tors, they received a presentation that warned that the central 

bank’s policies, and I am quoting from Bloomberg News, may be inflating bubbles and speculative grade bonds and other asset classes. 

Is this an acceptable side effect of the Fed’s expansionary policies? 

Mr. BERNANKE. As I have mentioned, it is a cost of these policies 

and it is one that we take very seriously. We look at these possible 

mispricings and we ask ourselves, are they in fact mispricings, how 

large are they? And if they are mispricings, what is the vulnerability? For example, if an asset is mispriced, is it being purchased 

using a lot of leverage? Who is owning it? Would its change in its 

price severely endanger our financial institutions? Those kinds of 

things. 

So we are examining this with a great of a deal of care. And 

again, I ask, what is the alternative? Interest rates are low for a 

good reason, but if in fact we have come to the conclusion that the 

cost of these mispricings are sufficient, then obviously we have to 

take that into account. 

Mr. MCHENRY. So to this point about inflation, many of us have 

this concern about how you are going to unwind this unprecedented 

portfolio that you preside over, or how your successor will unwind 

this, or your successor’s successor. And the concern that we have 

is that you only can see inflation with hindsight. 

And the question I have for you concerns the record of the 1970s: 

in 1973 expected inflation was 3.75 percent, that was the market 

expectation, the Fed said 3.9 percent, the actual was 6.2 percent; 

in 1974 expected inflation was 6.7 percent, the Fed said 8 percent, 

yet the actual inflation was 11 percent; in 1979 expected inflation 

was 8.3 percent, the Fed said 7.75 percent, the actual was 11.3 percent. And in 1980, expected inflation was predicted at 11 percent, 

the Fed said 7.5 percent, yet the actual was 131⁄2 percent. 

The Fed has consistently gotten it wrong. Are your tools better 

now to see inflation than they were then when we had this great 

period of inflation? 

Mr. BERNANKE. Our tools are better, but the environment is 

much better, because we now have 25 years of success in keeping 

inflation low and stable, and not just in the United States but 

around the world. Inflation expectations are very well-anchored 

and wages are growing very slowly. 

Chairman HENSARLING. The tme of the gentleman has expired. 

The Chair now recognizes the gentleman from Georgia, Mr. 

Scott, for 5 minutes. 

Mr. SCOTT. Thank you very much, Mr. Chairman. Over here, 

Chairman Bernanke. How are you? It is good to see you again. 

First, I want to commend you for the very courageous and bold 

work that you have done in the aggressive quantitative easing in 

which you have moved very forthrightly to strengthen our economy 

with the purchasing of Treasury and GSA securities, and I want 

to commend you for that. 

But, Chairman, I have always known you to be a straight shooter. I have great respect for you. We are on the eve of a very, very 

dramatic moment in American history dealing with this sequestration. And the President of the United States has said it is a terrible 

35 

thing to do. The Democrats have said it is a terrible thing to do. 

We are fighting to avoid it. The Secretary of Defense has come before us and said it is threatening our national security, we better 

not do it. We have had our Transportation Secretary, we have had 

Homeland Security Secretaries, but yet we have Republicans who 

are saying, and who are determined to move ahead and say, let’s 

do it. 

I want you to tell us today, who is right here? Who is telling the 

truth here? Is sequestration something that we should not do, as 

Democrats feel, or is it something we should do, as Republicans 

feel? What is in the best interest of America? 

Mr. BERNANKE. Congressman, you are asking me to make decisions which are not mine to make. Those are congressional decisions. Congress has to make those choices. 

What I am advising is a more gradual approach. I am not saying 

that we should ignore the deficit. I am not saying we shouldn’t deal 

with long-term fiscal issues, but I think from the perspective of our 

recovery, a more gradual approach would be constructive. 

Mr. SCOTT. When you say ‘‘gradual,’’ what specifically would 

gradual mean? Give us an example. 

Mr. BERNANKE. It works all in the same direction. The more 

gradual this is, as long as there are offsetting changes in the further horizon, the less the immediate impact will be on jobs and 

growth in this recovery in 2013. 

Mr. SCOTT. And do you agree that gradual approach should contain both spending cuts and additional revenue? 

Mr. BERNANKE. That, again, comes back to what Congress is responsible for. I am not going to comment on that. 

Mr. SCOTT. I am very, very concerned about this, because my 

home State of Georgia will suffer tremendously on this. I represent 

a district that has Lockheed Martin, for example, which has already come under tremendous job loss pressure. We are looking at 

over 60,000 jobs immediately. We are looking—and those jobs are 

teachers being laid off, firefighters being laid off, critical, critical 

manpower that is needed. 

Let me ask you: Friday comes, we go over the cliff with sequestration. What should we do next? Should we then try to consistently move to put something in place? How would you advise us 

to do that, and what would that step entail? 

Mr. BERNANKE. Again, the specifics are up to you, but what I 

would suggest would be replacing the sequester with something 

that is smaller, takes hold more slowly, but is compensated for by 

changes further out in the horizon. 

Mr. SCOTT. And do you see a complicating factor with the approaching deadline of the March CR? If, for example, we are unable 

to reach an agreement in 4 months, what impact would we have 

with sequestration moving rapidly through the system, massive job 

layoffs, all of the predictions coming true that we feel and then 

with our failure to reach agreement on the CR at the end of 

March? 

Mr. BERNANKE. The CR, I guess, would continue government 

services. I think there is some cost to the economy of these repeated, I don’t want to say crises, but these repeated episodes 

where Congress is unable to come to some agreement, and thereVerDate Nov 24 2008 16:58 Aug 02, 2013 Jkt 080869 PO 00000 Frm 00039 Fmt 6633 Sfmt 6633 K:\DOCS\80869.TXT TERRI
36 

fore some automatic thing kicks in. I think that is on the whole not 

a good thing for confidence. 

And, again, as I said yesterday, I realize that finding bipartisan 

agreement is very difficult, but I hope that you will work together 

to try to develop a less bumpy fiscal path in the near term. 

Mr. SCOTT. Thank you, Mr. Chairman. 

Mr. CAMPBELL. We now turn to the other gentleman from Georgia, Mr. Westmoreland. He is recognized for 5 minutes. 

Mr. WESTMORELAND. Thank you, Mr. Chairman. 

Chairman Bernanke, the Federal Reserve at this point is buying 

$85 billion worth of mortgage-backed securities a month, is that 

correct? 

Mr. BERNANKE. No, sir, it is 40 of mortgage backed and 45 of 

treasuries. 

Mr. WESTMORELAND. Okay, but a total of 85. 

Mr. BERNANKE. Yes, sir. 

Mr. WESTMORELAND. Because all the talk we have had about the 

sequester being $85 billion over a year for the whole Federal Government, I think when you realize what we are doing with these 

mortgage-backed securities, it kind of puts it in a perspective that 

do we really need to be buying that kind of securities every month? 

Mr. BERNANKE. This doesn’t involve any new spending or revenue. 

Mr. WESTMORELAND. I understand. Just printing money, right? 

Mr. BERNANKE. It is acquiring securities in order to reduce interest rates and ease financial conditions in the economy. 

Mr. WESTMORELAND. Let me ask you, I know that you make the 

decisions as far as what you think it will take, and I guess the 

Board of Governors, for what you think it will take to run the Federal Reserve, and as my colleague from Georgia mentioned, we represent a State that has had more bank failures than I think any 

other. I know my congressional district has more than any other 

congressional district. 

What is the Federal Reserve doing to let these banks which are 

community banks and they know their communities and they know 

their borrowers, what is the Federal Reserve doing to let them 

have more latitude in making some of the decisions about the 

banking needs of the community and how they can best solve that? 

Because what we basically hear is that the regulators, the FDIC, 

OCC, Federal Reserve, State regulators, are not really letting them 

answer the needs of the community. 

Mr. BERNANKE. We are very interested in the success of small 

community banks. We agree that they play a very important role 

in communities. We have a whole list of things, I won’t have time, 

but we have a Community Bank Council that comes and meets 

with the Board and gives their views. We have a special subcommittee of our Supervision Committee that is particularly focused on how rules can be made appropriate for smaller banks. We 

train our examiners to take into account the size of banks and 

their particular business models. We have all kinds of outreach. We 

are looking at our rules with the understanding that community 

banks can’t manage the same level of regulatory burden that large 

banks can handle. 

37 

So we are very committed to helping small community banks 

succeed in this environment. You have my assurance that is something we pay a lot of attention to. 

Mr. WESTMORELAND. I know that as I meet with my community 

bankers, and we have a little advisory board for the bank, and they 

are very concerned about Basel III, they are very concerned about 

the writedowns that they are having to do immediately rather than 

having some time period to do it. And I understand that you have 

all these things evidently in place to try to help the community 

banks. I just haven’t seen it. Nobody, none of my community bankers have said, hey, the Federal Reserve or the FDIC or anybody 

else is trying to help us stay open, they are giving us some latitude. 

So I just don’t see a big help going there. 

But I wanted to follow up on one of the questions that has already been asked. What do you think the amount is for a bank to 

be too-big-to-fail? Or is there an amount? 

Mr. BERNANKE. No. First of all, again, we are working again to 

get rid of too-big-to-fail, so any bank that fails would be subject to 

this Orderly Liquidation Authority. But in designating firms, for 

example, as systemically important, which is not the same as toobig-to-fail, we look at not just the size, but also the complexity, the 

interconnectedness to other banks, the kinds of activities they have 

and so on. So a simple dollar number is not really adequate to describe whether a bank is systemically critical or not. 

Mr. WESTMORELAND. I hope that as we continue to talk about 

too-big-to-fail, we will also look at the banks that are too-small-tosave. 

I yield back. 

Mr. CAMPBELL. The gentleman yields back. 

The gentlelady from Wisconsin, Ms. Moore, is recognized for 5 

minutes. 

Ms. MOORE. Thank you so much, Mr. Chairman, and thank you, 

Chairman Bernanke, for appearing today and tolerating this long 

testimony. 

I have a couple of questions for you. One of the consequences of 

our almost defaulting on our debt and the whole debt crisis, raising 

the debt limit, was we saw a lot of chatter around the world about 

abandoning the U.S. dollar as a reserve currency, and I am wondering what your outlook is on the economic growth or contraction 

of our economy were that to occur, that we would lose our status, 

that the U.S. dollar would lose the status of a reserve currency? 

Mr. BERNANKE. Let me say first that I don’t see any sign that 

is happening. The amount of reserves held in dollars is actually 

growing, not shrinking. So I think that reserve currency status at 

least for the foreseeable future is very much intact. If we lost that, 

it would probably have some effect on the interest rates that we 

pay because we would have fewer holders for our bonds and that 

in turn might have some impact on our economy. But, again, I 

don’t think that this is a very likely prospect in the foreseeable future. 

Ms. MOORE. Why did we have all the chatter about it, with the 

larger economies, Latin America, China? 

Mr. BERNANKE. Of course, the world is evolving. The Chinese 

would like their currency at some point to become a reserve curVerDate Nov 24 2008 16:58 Aug 02, 2013 Jkt 080869 PO 00000 Frm 00041 Fmt 6633 Sfmt 6633 K:\DOCS\80869.TXT TERRI
38 

rency. There is some distance for them to go before they can get 

to that point. But, as I said, at least in the near term, pretty close 

to two-thirds of all global reserves are held in dollars, and that 

doesn’t seem to be changing very much. 

Ms. MOORE. Thank you. 

Listen, I want to talk about too-big-to-fail as well, global too-bigto-fail, and I want to say that I was really pleased to see the FDIC 

and the European Commission working together to establish a 

legal framework to create a global system for unwinding large systemically important firms similar to our Orderly Liquidation Authority that we created in Dodd-Frank. 

Is there more that this committee and Congress can do towards 

this effort or other cross-border efforts? And I would be interested 

in hearing about other efforts that the Fed is undertaking to further coordinate global monetary policy, particularly with bank regulation standards, and anti-money laundering efforts. What other 

things are you doing? 

Mr. BERNANKE. On an Orderly Liquidation Authority, as you 

mentioned the FDIC, which is leading this effort, has been working 

with European counterparts. They published a paper with the U.K. 

authorities, I believe it was a few months ago. The Fed has been 

working very closely with the FDIC. Recently, for example, I attended a table top exercise where we pretended that there was a 

bank failing and asked ourselves what we would do under the laws 

that Orderly Liquidation Authority provides. The Financial Stability Board, which is an international body of regulators, and 

other international bodies like the Basel Committee and so on, 

have been discussing the issues related to international banks and 

how they might be liquidated in a crisis. 

That is the most difficult issue, I think, that we still have to 

work on. But we are making progress, and there is a lot of international interest in finding ways to work together to deal with the 

institution which crosses many borders. More generally, the level 

of international cooperation in regulatory matters is quite high. 

There are a number of international bodies. The U.S., the U.K. and 

the other major banking centers cooperate quite extensively on 

these issues. The CFTC and the SEC are working on derivatives 

issues. So there is a lot of work going on. 

On monetary policy, we exchange ideas and discuss the economy 

quite frequently in different settings, but we don’t directly coordinate monetary policy in the sense that we agree as a general matter to take actions together or in some sequence. 

Ms. MOORE. Thank you, Mr. Chairman. My time is limited so I 

just want to make a comment. You may not have time to respond 

to it. I did notice in your testimony that you noted that all taxing 

and spending decisions that Congress makes, and I know you don’t 

like to comment on what we do, but that they are not equal. So, 

for example, lowering taxes on the wealthy does not necessarily 

have the same impact on our economy as giving unemployment 

benefits to the unemployed. Yes or no? 

Mr. BERNANKE. Different taxes and different spending have different implications. 

Ms. MOORE. Right. 

Chairman HENSARLING. The time of the gentlelady has expired. 

39 

The Chair now recognizes the gentlelady from Minnesota, Mrs. 

Bachmann, for 5 minutes. 

Mrs. BACHMANN. Thank you, Mr. Chairman, and thank you, 

Chairman Bernanke, for being here today. I was reading your testimony, and I thank you for giving it, especially on pages 7 and 8. 

On page 7, you talked about the sequestration and the impact of 

the sequestration and your concerns about that impact currently on 

the short term and the economic drag that could bring about. Then 

on page 8, you talked about the fact that at some point down the 

road we have to deal with our current debt and our current overspending. You had also said in your comments before us that we 

need to align our solutions with the problem, meaning I take it 

that the spending reductions shouldn’t happen today, they should 

wait until tomorrow when we really start to have problems. 

So is that how you would quantify that, yes or no? 

Mr. BERNANKE. I didn’t say we have to get rid of the spending 

cuts today, but just more gradual introduction combined with 

longer-term measures. 

Mrs. BACHMANN. So let me ask you—some very quick kind of 

technical answers is what I am looking for. What was the United 

States’ deficit last year? 

Mr. BERNANKE. I have it right here. It was $1.09 trillion. 

Mrs. BACHMANN. $1.09 trillion. And what was our total national 

debt for last year, or currently? 

Mr. BERNANKE. About $11 trillion. 

Mrs. BACHMANN. And what is our current total national debt this 

year? 

Mr. BERNANKE. It is currently, I think, about $11.5 trillion. 

Mrs. BACHMANN. Not 16.5 trillion? 

Mr. BERNANKE. The $16 trillion includes intra-governmental debt 

like the Social Security Trust Fund. But debt held by the public as 

opposed to debt held between different parts of the government is 

about $11.5 trillion. 

Mrs. BACHMANN. So you are saying the debt is about $11.5 trillion. And what are the unfunded net liabilities? 

Mr. BERNANKE. They are very large, particularly in the Medicare 

area. I don’t have a number, but they are probably some greater 

than the actual official debt held by the public. 

Mrs. BACHMANN. And how much debt do we buy every day from 

the Treasury, from the Federal Reserve? 

Mr. BERNANKE. Every day? About $1.5 billion? 

Mrs. BACHMANN. About $1.5 billion. So without the Fed purchases of our debt from the Treasury, would we be able to continue 

the spending level? 

Mr. BERNANKE. Yes, you could. As I said before, the Fed only 

owns about 15 percent of the outstanding U.S. Government debt. 

Mrs. BACHMANN. Where would we go? If we didn’t have the Fed 

buying that debt, where would we go? 

Mr. BERNANKE. Our debt is in great demand. Foreigners hold 

about half of it. People think of U.S. Treasury debt as a safe haven 

and as a secure investment. That is why, notwithstanding what the 

Fed is doing, we can sell it at low interest rates. 

40 

Mrs. BACHMANN. So the Fed wouldn’t need to be buying all these 

Treasuries then, we could find other buyers for our debt, is that 

true? 

Mr. BERNANKE. Yes. 

Mrs. BACHMANN. So then why are we doing it? 

Mr. BERNANKE. To keep rates a little bit lower, to help support 

housing, automobiles, and other parts of the economy that need 

more support. 

Mrs. BACHMANN. But if there are other buyers, why the Fed? 

Mr. BERNANKE. To get rates a little bit lower than they otherwise 

would be. 

Mrs. BACHMANN. So if my 18-year-old daughter was spending 40 

percent more than what my husband and I were giving her, and 

she didn’t do that just this month, but she did it next month and 

the next month and the next month, and finally my husband and 

I said we are just not going to bail you out anymore, we are just 

not going to continue to finance the overspending that you are 

doing, and she said to me, mother, we need to align our solution 

with the problem, in other words, you need to keep giving me that 

money because it is really not a problem yet. I would say I think 

you have a problem today. And the reason why I would say that 

is because the analogy with the Federal Government, in January 

of 2007 our debt was $8.67 trillion. That debt today is closer to 

$16.5 trillion, with the intra-government debts, according to your 

calculation. 

Do you think that is a problem, that in 6 years we have gone 

from $8.67 trillion to $16.5 trillion? 

Mr. BERNANKE. Certainly that is a problem, and that is why I 

think it is important to have measures to bring it down over time. 

Mrs. BACHMANN. But you said we need to align the solution with 

the problem. It seems to me we have a big problem, and I will tell 

you why. When I was home last week and talking to a lot of 

women, they were telling me, ‘‘I don’t get this. Gasoline at Christmastime was $2.99 a gallon. Now, it is $4 a gallon.’’ They said, ‘‘I 

can’t keep up with the price increases at the grocery store. And we 

just got our health insurance premium and it is going to be $300 

a month more than what it was.’’ 

So all I want to say, Mr. Chairman, is that what I am hearing 

from the people is that they are having to deal with the inflationary problem. 

Chairman HENSARLING. The time of the gentlelady has expired. 

The Chair now recognizes the gentleman from Texas, Mr. 

Hinojosa, for 5 minutes. 

Mr. HINOJOSA. Thank you, Mr. Chairman. 

Chairman Bernanke, thank you for coming to visit with our committee and thank you for your leadership and for your foresight in 

the handling of our fiscal policy. Your testimony comes at a pivotal 

time in our Nation’s Capital. 

While we want to address the long-term health of the Federal 

balance sheet, the sequester cuts are so drastic and so immediate 

that they greatly threaten economic growth. In your remarks, you 

suggest Congress consider a longer-term horizon for targeted fiscal 

changes, and I completely agree with you. The sequester is totally 

41 

unnecessary and illustrates a lack of political courage by Members 

of Congress. 

We have spent a lot of time in this committee attempting to reduce uncertainty in the economy. We have done it by reducing uncertainty for banks, by finalizing rules, and we have done it by reducing uncertainty for small businesses by encouraging lending. 

Uncertainty around effects of the sequester is no doubt already 

chilling the economy and confusion over the continuance of quantitative easing also creates uncertainty. For example, when word 

spread on Wall Street that the Federal Open Market Committee 

was considering ending or altering QE3, the Dow Jones dropped 

significantly. We cannot throw more uncertainty into such a fragile 

economy and have consumer confidence erode. 

Many of my friends across the aisle will argue that current fiscal 

policy is causing the economy to overheat. At the same time, all of 

us are concerned about still too high unemployment. How can a socalled overheating economy see employment grow so slowly? And 

furthermore, Chairman Bernanke, I would like to ask you, do you 

think that our economy is indeed overheating, and can you give us 

a sense of where the economy would be had you not implemented 

quantitative easing? Also discuss with us the impact of a sudden 

fiscal contraction on economic uncertainty, and ultimately tell us 

about the recovery that you foresee. 

Mr. BERNANKE. I don’t think the economy is overheating. There 

still seems to be quite a bit of unused resources, a lot of people out 

of work who could be working, capital that could be used that is 

not being used. So, again, I don’t see any overheating. 

We believe that the monetary policies that we have conducted 

have helped get stronger recovery and more jobs than we otherwise 

would have had. There have been different studies that give different numbers, but most of them do find a pretty significant effect. 

On the fiscal side, as I mentioned, the CBO attributes to the sequester about six-tenths of a percentage point of growth in 2013 

which they connect to the full-time equivalent of about 750,000 

jobs. So from the CBO’s perspective, there is an important job component or job effect arising from fiscal contraction which, again, as 

I have said many times, the Federal Reserve really can’t overcome. 

We don’t really have tools sufficiently powerful to overcome the impact of those types of fiscal actions. 

Mr. HINOJOSA. Do you believe that the sequester kicking in on 

Friday would lead the markets to tumble? 

Mr. BERNANKE. The markets already know about the sequester. 

It isn’t news to them. So I don’t think necessarily that the markets 

will respond to the beginning of the sequester. But, again, I think 

a good policy, one that would be good for the economy and probably 

good for markets, would be one that, again, takes a longer-term 

perspective and takes some significant steps to address our longerterm fiscal imbalances while phasing in more slowly some of the 

changes occurring at the present time. 

Mr. HINOJOSA. I ask that question because I spoke to a lot of 

teachers, a lot of people who have 401(k)s and saw what happened 

in 2008 when the markets tumbled about 40 percent and they lost 

so much equity, and they are concerned that might happen again. 

Chairman HENSARLING. The time of the gentleman has expired. 

42 

The Chair now recognizes the gentleman from New Mexico, Mr. 

Pearce, for 5 minutes. 

Mr. PEARCE. Thank you, Mr. Chairman. 

Thank you, Chairman Bernanke, for being here, and for your 

presentation today. I would like to echo what Mrs. Capito said 

about the energy economy, and the three counties in the southeast 

part of New Mexico where $100,000 jobs driving a truck are going 

wanting. The Occupy People say they don’t have jobs, but they 

don’t come out where they are. And they are good paying jobs. At 

my last job fair, we were trying to bring people and put them together with folks who were looking for workers, and 14 driving jobs 

in one company went without being filled, and 3,000 jobs at another job fair went wanting, and the Nation treats this like it is 

some sort of secondary effect. Nationwide, I would point out that 

the Bureau of Labor Statistics shows 3.6 million jobs are available 

right now in America, and yet we have 8 percent, 7.5 percent, 

whatever percent unemployment, and I think at some point, the 

country needs to deal with that. 

I would also like to echo what Mrs. Capito said about the seniors. 

Her seniors seem to be a little more gentle than mine. I just had 

a telephone town hall last night and Susan from Los Ninos and 

Leone from my district also were quite energized about the whole 

concept of quantitative easing. And I know that the price of gasoline and the price of groceries don’t rise to the level of importance 

to where the Feds would actually measure those in the computations, but we are 47th per capita income, and when we are told 

that inflation is not going up at all, it is eating the lunch of our 

seniors who can’t afford to fill their fuel tanks and buy groceries. 

Now, I would invite you to come and sit with me in an open town 

hall in New Mexico. Would you be open to that? We could contact 

your scheduler maybe. 

Mr. BERNANKE. You can talk to the scheduler to see if it is possible. 

Mr. PEARCE. I would take that as a very positive sign that you 

would be interested in talking to people on that end of the economic ladder. But they don’t buy these explanations that quantitative easing is this great miracle that I am hearing today, but 

they understand the creation of money out of thin air depreciates 

what they have, and as always, inflation hurts the poor worse than 

anyone else, and that is our district. 

So Susan asked, would you put all your money—just so you get 

the full benefit of zero interest rates, why don’t you put all of your 

money in savings accounts? Because many of these people are unsophisticated investors, like Chairman Garrett suggested. They are 

not comfortable. They don’t know all these risky things. They see 

Wall Street and they see all the derivatives and all this jazz that 

got everybody hyped up and cost us several trillion dollars to pay 

back those people who took those risks, but they don’t buy it. 

And they are furious with the government. They say, ‘‘We lived 

our life right. We paid off our homes. We put money into the bank. 

We had a nest egg that was sufficient at the going rate of interest. 

And now our government is bragging that we have zero interest 

and we are being punished after living our lives correctly.’’ My 

mom is in that category. She is 80-something; I hope that she 

43 

doesn’t go out and start finding a stock investor right now. So I 

think at some point it would be nice for you to get out among people who have manure on the bottom of their boots like we do in 

New Mexico. 

You spend a lot of time on page 7 quoting the CBO about the 

effects of the sequester. You even talked about it. But I was unsure 

if you agree with the CBO or if you simply are quoting the CBO. 

Are you in full agreement with the effects that you have put into 

your paper? 

Mr. BERNANKE. Broadly speaking, yes. 

Mr. PEARCE. Fairly speaking, I am wondering, you also say that 

there were temporary interruptions to the economy, the weatherrelated interruptions to the economy. That is page one of your testimony. I am seeing in the Financial Times that Wal-Mart and all 

the other retailers are worrying about that price increase or the 

payroll tax increase that was passed along at the end of last year 

as being maybe as big an effect. The cost is about the same, $95 

billion more or less. And yet I don’t find any reference, I don’t find 

a reference to the penalizing effect that that tax increase had. 

Mr. BERNANKE. I did mention that the overall effect of all the 

changes is about 1.5 percentage points, and that includes the payroll. 

Mr. PEARCE. But you do mention the sequester. You use a little 

bit different language. You don’t actually come out and say ‘‘the sequester,’’ but you do mention that our solutions are going to cause 

great headwinds, but you don’t mention the headwinds from that 

other decision there to raise taxes. 

Mr. BERNANKE. I did mention those, yes. 

Mr. PEARCE. I find the omission very curious. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from North Carolina, 

Mr. Watt, for 5 minutes. 

Mr. WATT. Thank you, Mr. Chairman, and I thank Chairman 

Bernanke for being here. I apologize for being late. I was over in 

the Supreme Court listening to the arguments on the voting rights 

case. Sometimes, it is kind of difficult to be in two places at one 

time, I have found. 

I want to go back to the prior questioner because my constituents 

obviously are living in a slightly different world than his and are 

getting ready to live apparently in a more significantly different 

world than his unless we do something between now and Friday. 

We spent a lot of time in yesterday’s hearing talking about the impact of sequestration, and it is really vexing a lot of people, although I confess that most people don’t know what a sequester is. 

You say at the top of page 7 that monetary policy is working to 

promote a more robust recovery but it can’t carry the entire burden 

of ensuring a speedier return to economic health. The economy’s 

performance, both over the near term and in the longer run, will 

depend importantly on the course of fiscal policy. That is something 

which is under the Congress’ control, as opposed to monetary policy, which is under the Fed’s control. And you make some observations about the short- and long-term impact. 

I am wondering if you have some views about the impact, the 

likely impact, notwithstanding the monetary policies that the Fed 

44 

has implemented, of sequester in the form that it is about to take 

effect if we don’t do anything between now and Friday? 

Mr. BERNANKE. I haven’t made any comment about the specific 

allocation of cuts across different departments. Those are issues for 

the Congress to debate. What I did was cite the CBO numbers, 

which again I think are reasonable, which suggest that all of the 

fiscal measures, including the payroll tax increase, are equal to 

about 1.5 percentage points of drag this year, and that the sequester by itself is about six-tenths of drag according to the CBO and 

according to I think most standard analyses. 

Mr. WATT. And you said you generally agreed with the CBO’s 

analysis of that? 

Mr. BERNANKE. Yes. 

Mr. WATT. All right. So you are saying that sequestration could 

have six-tenths of one percentage impact— 

Mr. BERNANKE. On the growth rate. It brings the growth rate 

down. 

Mr. WATT. On the growth rate. Okay. And in this kind of economy that is fragile, what would you project would be the consequences of that? 

Mr. BERNANKE. The CBO suggests that the job impact in full 

time equivalents would be about 750,000. 

Mr. WATT. So that is 750,000 more people unemployed than 

would otherwise be. 

Mr. BERNANKE. Than would otherwise be the case. Or an unemployment rate that might stay where it is or go up a little rather 

than coming down by the end of the year. 

Mr. WATT. And what about the uncertainty associated from a 

business and economic perspective? What would you project there? 

Mr. BERNANKE. It is hard to measure the uncertainty effects, but 

there has been a whole sequence of events going back to the 2011 

debt ceiling debate, and now we have had the fiscal cliff and sequester and all these things, and what we hear at least anecdotally 

from people around the country is that it does create uncertainty 

and makes it more difficult for them to plan, to hire, to invest. 

Mr. WATT. More difficult for them to hire and invest. I wanted 

to reemphasize that. So you think— 

Chairman HENSARLING. The time of the gentleman has expired. 

Mr. WATT. I yield back. 

Chairman HENSARLING. The chairman recognizes the gentleman 

from Pennsylvania, Mr. Fitzpatrick, for 5 minutes. 

Mr. FITZPATRICK. Thank you, Mr. Chairman. 

Mr. Bernanke, thank you for your time and your insight here 

and your service to the people. When you were here last year, the 

Bureau of Labor Statistics (BLS) indicated that the unemployment 

rate was higher than it is today. Today, I think the BLS is saying 

it is about 7.9 percent, although most people throughout the country believe it is much higher, including people in Bucks County, 

Pennsylvania, which I represent, especially among younger workers, especially recent graduates, just graduating from high school 

trying to get in the market. 

I spoke earlier today on the other side of the city to the American 

Legion about the increasing number of returning veterans from Afghanistan, and some believe that the unemployment rate among 

45 

veterans is twice the national average, and, of course, all of this is 

unacceptable. So from 2001 to the present, our country has had a 

significant increase in population. We have increasing numbers of 

veterans coming home looking for work in a very difficult economy. 

Some are suggesting because there are fewer people working 

today than were working, employed today than were working in 

2001, that our country may have just experienced a lost decade 

similar to what Japan went through in the 1990s and the 2000s. 

Do you agree with that? Are there any differences between what 

happened in Japan and what is happening here in our country, and 

if so, what policy suggestions would you make to address it? 

Mr. BERNANKE. There obviously has been a very severe, difficult, 

economic period. I don’t know about calling it a lost decade. There 

are important differences between the United States and Japan. 

Japan has an even more rapidly aging society than we do. Their 

workforce is actually declining. They have had more difficulties 

with their banking sector. We were more rapid in getting our 

banks up and running again, so to speak. And, very importantly, 

the Federal Reserve has kept inflation close to 2 percent and we 

have avoided deflation, which was the major problem for the Japanese. 

In terms of what to do about it, first of all, there are many things 

that could be done to address our long-run economic prosperity in 

terms of good tax policy, and good decisions about encouraging public and private infrastructure, things that I mentioned at the end 

of my testimony. 

In the short term, it is our view that there is still a good bit of 

slack in the economy, that we are not using all the resources we 

have. As you mentioned, we have very high unemployment in certain categories, and that is the basis both for the accommodative 

monetary policy that we have, keeping interests rates low and trying to stimulate housing and durable goods and so on, and also for 

the recommendation that fiscal policy go gradually as Congress 

tries to address the long-term deficit issues. 

Mr. FITZPATRICK. The Fed has indicated that it believes in the 

long term, unemployment rates will settle at around 5.2 or 6 percent? 

Mr. BERNANKE. That is our best guess. 

Mr. FITZPATRICK. I understand, and I heard testimony earlier 

about predicting the future, but when would you say we might get 

to around 6 percent? And also, the American people believe natural 

unemployment is actually much lower than that, given what we experienced in the 1990s, and maybe your suggestion as to how we 

address that expectation? 

Mr. BERNANKE. Again, it is hard to predict, but a reasonable 

guess for 6 percent would be around 2016, about 3 more years. 

Mr. FITZPATRICK. In my remaining time, I just wanted to address 

the issue of the Fed’s bond buying program. You said in your testimony last September that the FOMC announced it would purchase 

agency-backed mortgage securities at the pace of $40 billion per 

month, additionally $45 billion per month for Treasury securities. 

The FOMC has indicated it will continue purchases until it observes a substantial improvement in the outlook for the labor market in the context of price stability. 

46 

First of all, what would be the target improvement for the slowdown? 

Mr. BERNANKE. We haven’t given a specific number. We are looking for improvements in terms of employment, in terms of unemployment, in terms of a stronger economy that can deliver more 

jobs. The reason we haven’t given a specific number, besides all the 

uncertainties involved, is that we are also looking at the efficacy 

and costs as I have described in my testimony. If all else is equal, 

if there are costs being generated by this policy that are concerning, that would, all else equal, make us do less. If it is more 

efficacious, then we might do more. 

Mr. FITZPATRICK. In my remaining 20 seconds, can you give us 

what a proposed strategy would be for the acquired positions that 

the Fed has right now, sales strategy? 

Mr. BERNANKE. For the assets? 

Mr. FITZPATRICK. For the assets, right. 

Mr. BERNANKE. We have been clear that at the time we decide 

to begin sales, we will give plenty of notice and proceed slowly and 

do so in a way consistent with our macro objectives. 

Mr. FITZPATRICK. I thank the chairman. 

Chairman HENSARLING. The time of the gentleman has expired. 

The Chair now recognizes the gentleman from Connecticut, Mr. 

Himes, for 5 minutes. 

Mr. HIMES. Thank you, Mr. Chairman. 

Mr. Chairman, let me add my voice to those who have complimented you and thank you for your efforts over the last years 

to restore our economy to vitality. I suspect that when the history 

books are written, we will look at the twin engines of monetary and 

fiscal policy in this country and you will emerge as somebody who 

acted wisely and in good faith, and those of us charged with fiscal 

policy certainly in the last 2 years will be regarded at best as having dithered and at worst as having acted counterproductively to 

economic recovery. And I appreciate that throughout your testimony as well as throughout this report, you warn us of the dangers 

of premature sizable fiscal contraction, something which I have 

heard from the other side of the aisle over the course of the last 

2 years is regarded by them as essential to our recovery. We have 

a theoretical discussion about that around Keynesianism and this 

and that. 

I do want to ask you a question though. In this report on monetary policy, you talk about the Euro area, and the report reads, 

‘‘The Euro area fell further into recession as fiscal austerity and 

other things led it a reduction in spending.’’ 

To take this discussion out of the theoretical, any number of 

countries in the Euro area, Ireland, the U.K., Italy, Spain, pursued 

fiscal policies significantly more contractionary than our own. I 

wonder as you contemplate the Euro area, and here we are looking 

at sort of a real-time experiment and policy response, is there any 

country in the Euro area that pursued more aggressively 

contractionary fiscal policies than our own that has seen economic 

expansion, job creation, and meaningful reduction in debt to GDP? 

Mr. BERNANKE. I don’t think so. 

Mr. HIMES. So there is really no country that has pursued the 

kind of austerity policies that we have heard some in this instituVerDate Nov 24 2008 16:58 Aug 02, 2013 Jkt 080869 PO 00000 Frm 00050 Fmt 6633 Sfmt 6633 K:\DOCS\80869.TXT TERRI
47 

tion call for that have experienced economic growth or a reduction 

in the debt to their economy? 

Mr. BERNANKE. I think Germany has had the best experience, 

but even there they have had a shrinking economy recently. 

Mr. HIMES. Thank you. I appreciate that answer. 

To change topics here, I was very interested in the exchange that 

you had in the Senate, I believe yesterday, on the topic of DoddFrank. Senator Crapo, I think, asked to you reflect on what elements of that legislation you thought were good and perhaps which 

elements could stand improvement or that this institution should 

perhaps revisit, and I think you specifically highlighted Section 716 

as an area that you thought perhaps we could revisit. 

I wonder, could you elaborate a little bit on Section 716, but also 

I would love to have you extend that discussion just based on what 

you have done in the last couple of years. What other areas do you 

think perhaps we may have gotten wrong or where perhaps we are 

experiencing unintended consequences or have created problems for 

the regulators in terms of implementation? 

Mr. BERNANKE. Section 716 requires the push-out of certain 

kinds of derivatives, which means that banks can’t manage those 

derivatives, they have to be in a separate company, a separate affiliate, and it is not evident why that makes the company as a whole 

safer. What we do see is that it will likely increase costs of people 

who use the derivatives and make it more difficult for the bank to 

compete with foreign competitors who can provide a more complete 

set of services. So there are some concerns about that particular 

rule. 

I think more generally though we want to ask the question, can 

we achieve the same objectives more efficiently, and more cheaply, 

and I think a review of some of the different elements would be 

useful. A number of people have mentioned concerns about community banks and small institutions, and I think an inventory, a 

broad inventory of the regulations affecting small banks would be 

worth doing in order to try to assess whether there are places 

where we can simplify and reduce the burden for those banks. 

Mr. HIMES. Thanks. That is helpful. Would you be willing to 

comment in this context, Dodd-Frank and its subsequent regulatory implementation, how you think about the extent to which 

the broader too-big-to-fail problem has been addressed and are 

there areas where you think we could do better or differently? 

Mr. BERNANKE. Dodd-Frank has a pretty comprehensive strategy 

for addressing too-big-to-fail. I think it is too early to say. I think 

we have made some progress, but I think it is too early to make 

a definitive conclusion because many of the relevant regulations 

are not even in effect yet. But, again, I think there is a strategy 

here and I think we ought to continue to pursue it and see how 

it shakes out. If it doesn’t achieve the objective of eliminating toobig-to-fail, I think we ought to come back and decide or ask Congress whether they might take additional steps. 

Mr. HIMES. Thank you, Mr. Chairman. 

Chairman HENSARLING. The time of the gentleman has expired. 

As a process point, the chairman will be the bearer of bad news 

to some Members on our current schedule. To respect the Chairman’s schedule, it is likely that Representatives Luetkemeyer, CarVerDate Nov 24 2008 16:58 Aug 02, 2013 Jkt 080869 PO 00000 Frm 00051 Fmt 6633 Sfmt 6633 K:\DOCS\80869.TXT TERRI
48 

ney, Huizenga, and Kildee will likely be the last Members to be 

able to ask questions. 

At this point, the Chair will recognize Mr. Luetkemeyer of Missouri for 5 minutes. 

Mr. LUETKEMEYER. Thank you. Thank you, Mr. Chairman, and 

thank you, Chairman Bernanke, for being here and enduring 3 

hours of this again. 

I have some concerns with regards to the way we are going with 

quantitative easing from the standpoint that even in your own report here you talk about Japan, you talk about England, and you 

talk about China. All three have used quantitative easing and yet 

all three of them have, even in your own document here, their 

growth has continued to go the wrong direction. And I am curious 

about that. 

Even in The Wall Street Journal yesterday, it said that China 

now has it its own debt bomb. And one of the statements that it 

made in there is that through 2007, creating a dollar of economic 

growth in China required just over a dollar of debt. Since then, it 

is now taking $3 of debt to generate a dollar’s worth of growth. 

This is what you normally see in the late stages of a credit binge 

as more debt goes into increasing less productive investments. 

So I guess my question is, while we are heading down the same 

path as these other countries, and my neighbor here, my friend to 

the left a while ago mentioned about Japan and their 20 years of 

trying this quantitative easing and now they have a stagnant economy, they have weak industries, they have little growth, and yet 

they have 200 percent of debt to GDP. We are headed down that 

same road, and obviously even your own documentation shows it 

is questionable whether it even works. What would be your response? 

Mr. BERNANKE. I think the evidence for the United States is that 

while it is not incredibly powerful that it does work, we have seen 

a recovery that is not as fast as we would like, but it is nevertheless stronger and more meaningful than many other industrial 

countries. 

One way of interpreting Japan on the monetary side is that they 

were too cautious in that one of the most salient facts about Japan 

is that they have had deflation, falling prices now for quite a few 

years, and that is suggestive of a monetary policy which is not 

achieving price stability. And, as you know, the new prime minister 

and new governor of the Bank of Japan are promising more aggressive policies to try to eliminate deflation. So you could look at that 

either way. 

It is a problem for us that our normal short-term interest rate 

policies are no longer available because short rates are close to zero 

and so we have had to go to different methods as I described. But, 

again, our best estimates suggest that it has had a meaningful beneficial effect, and I have tried to be completely frank with this committee and talk about the downside as well because I would like 

you to understand the kind of cost-benefit analysis that we are 

doing. 

Mr. LUETKEMEYER. I have some concerns from the standpoint 

that I don’t know that we are doing things differently than other 

countries here, but hopefully you feel that we do. 

49 

The other thing is you mentioned an exit strategy, and I understood what you were saying a while ago when you were talking 

about how there are different ways of going about it. Has any other 

country ever done this, had this large increase in the central bank’s 

portfolio and then unwound it so that we know that this is a tested 

strategy that would work? 

Mr. BERNANKE. Not in a precisely analogous way, because Japan, 

after all, which is really the only other country prior to the crisis 

which had used quantitative easing is still in that situation. But 

the tools that we are using or propose to use, such as the interest 

on reserves, for example, or the draining of reserve tools that we 

have, those have been used quite frequently by other central banks 

and they seem to work in their context. 

Mr. LUETKEMEYER. Okay, one more quick question here before 

my time runs out, and it is with regards to a statement or comment you made in your opening statement, that the Federal Reserve is responding accurately to the financial stability concerns 

throughout substantially expanded monitoring of emerging risks in 

the financial system and approach to the supervision of financial 

firms that takes a more systemic perspective and the ongoing implementation of reforms to make the financial system more transparent and resilient. 

Can you give me some examples of things that you are doing 

with regards to systemic supervision, implementation of reforms, 

give me some specific examples? 

Mr. BERNANKE. Sure. On the monitoring, we have greatly increased resources just to monitor all the different sectors of the financial markets. Both the Fed and the Financial Stability Oversight Council are doing that. 

In terms of macro-potential oversight, one good example is the 

stress testing that we now do, where we ask the largest banks to 

figure out what would happen to their capital if there was a very 

severe downturn in the economy and a very big decline in financial— 

Mr. LUETKEMEYER. Let me interrupt for one second. I am running out of time here. Can you give me examples of reforms to 

make the system more transparent and resilient? 

Mr. BERNANKE. The Basel rules, for example, require more disclosure. Our stress tests, we publish the results so that the markets know what the results are for each individual bank. 

Mr. LUETKEMEYER. Thank you very much. My time has expired. 

Thank you very much for your answers. 

Chairman HENSARLING. The time of the gentleman has indeed 

expired. 

The Chair now recognizes the gentleman from Delaware, Mr. 

Carney, for 5 minutes. 

Mr. CARNEY. Thank you, Mr. Chairman, and thank you, Chairman Bernanke, for your testimony today, for your report, and really for your great leadership on monetary policy for our country over 

the last several years. I think you are the right person at the right 

time for what we needed. And you have given us, frankly, great advice. We haven’t really followed it with respect to smart fiscal policy. We appreciate your comments on that. You have consistently 

said that we need to be careful in the short term, do no harm in 

50 

the short term, if I may, and address our long-term imbalances, fiscal imbalances in the outyears. 

In your testimony, you say specifically that the Federal deficit 

and debt as a percentage of GDP will begin rising again in the latter part of this decade, reflecting in large part the aging of the population and fast rising health care costs. 

Do you believe as I do that health care costs are the primary 

driver of our outyear deficits? 

Mr. BERNANKE. They are. Yes. 

Mr. CARNEY. From our perspective, we have Medicare, Medicaid, 

Federal employees, military health care. What should be our goal? 

What we should be focusing on? Have you thought much about this 

as it relates to what the country needs to do with these fiscal challenges? 

Mr. BERNANKE. As you know, health care is a very complicated 

subject and nobody has a single answer. I think one way of describing our problem is we have fee-for-service and third-party pay together, which means that doctors can order as many tests as they 

want and the patient doesn’t care because they know somebody 

else will pay for it. There are many different ways to address that. 

One way is to have the consumer bear some of the financial costs. 

Another way is to have tighter controls from the government which 

is paying the cost. So there are many different approaches. Certainly, we want to be rewarding doctors and hospitals for quality. 

We want to have more transparency about their processes. 

Mr. CARNEY. How about health care as a sector? Should we be 

looking at—we have these debates in my State of Delaware all the 

time about somebody is expanding and building a new hospital 

right down the street from where I live, a new surgery center put 

here. And we talk a lot about economic development. I think you 

could also see it as frankly an increase in overhead. Those costs are 

going to be borne by somebody, and they are either employers or 

the government it seems to me. 

How would an economist look at that in terms of the health care 

sector writ large and health care employment? 

Mr. BERNANKE. That is exactly right. We have scarce resources. 

We don’t have infinite amounts of money to spend on health care. 

We want to deploy it in ways that have the greatest benefit for the 

least cost, and there are different ways to go about doing that. But 

clearly, getting the per capita cost of health care under control 

would not only be very good for the Federal budget, but it would 

be a terrific thing for our economy more broadly because, of course, 

individuals and companies also pay health care costs. 

Mr. CARNEY. So you may not want to comment on this, but one 

of the specific ideas that have been floated is to increase the age 

for Medicare eligibility, which doesn’t do anything for the cost of 

the people who have that. As I see it, it just shifts that cost from 

the government frankly or from that system to the private sector 

or private payors. Do you have any thoughts on that generally? 

Mr. BERNANKE. It relates to what I just said, which is this is not 

just a Federal fiscal problem, it is an economy-wide problem, and 

so the real solutions, the real lasting solutions will involve changing the way we pay doctors and hospitals so that they will have 

51 

the incentives to keep costs under control, whether it is the government paying it or whether it is a private sector person paying it. 

Mr. CARNEY. Thank you. One last question. You mentioned earlier when we were talking about too-big-to-fail with Representative 

Capuano that you no longer, under Dodd-Frank, have the tools that 

were available to you in 2008. Do you need additional tools? There 

has been a lot of discussion among people that I have talked to 

about in addition maybe to Orderly Liquidation Authority, which 

I guess a district judge would order having some sort of enhanced 

financial bankruptcy, that might be an option as well. Do you have 

any thoughts on additional tools? 

Mr. BERNANKE. No, we are not asking for any additional tools at 

this juncture. We continue to work on the Orderly Liquidation Authority with the FDIC, and at some point it would be a good idea 

for Congress to review that process and see if you are comfortable 

with the approach that the FDIC in particular has suggested for 

dealing with a failing firm. 

Mr. CARNEY. Thank you, Chairman Bernanke. 

I yield back. 

Chairman HENSARLING. The Chair recognizes the gentleman 

from Michigan, Mr. Huizenga, for 5 minutes. 

Mr. HUIZENGA. Thank you, Mr. Chairman. I appreciate that. 

Chairman Bernanke, I appreciate you being here as well. I am 

going to try to move quickly and express some opinions, but I also 

have a couple of questions, and I too want to sort of log my caution 

on what we have been doing with our monetary policy and the easing that we have had. 

There has been lots of discussion about this economy being very 

fragile, I have heard a number of my friends and colleagues over 

there, and why we ‘‘can’t allow the across-the-board cuts to go in 

place.’’ But it seems to me that no one is really commenting on the 

tax increases proposed by the White House or the increased regulation that we are seeing, whether it is through the EPA, certainly 

through Dodd-Frank that this committee is dealing with, et cetera, 

et cetera. 

As one of my business owners back home put it to me, he said, 

‘‘Look, it is not like this one little piece, this one grain of sand, is 

going to stop the machine. But when you start adding 10 or 20 or 

30 or 40 or 50 and then you start pounding it in with a mallet, suddenly that little grain of sand does start grinding on that machine 

and it breaks it down.’’ I think that is exactly what we have seen 

with much of the regulation. 

But in addition to that, we haven’t talked about the hit from the 

tax rate lapses, the so-called Bush/Obama tax rates that were 

there, and I would like to see my friends have a greater conversation about that. At the time, Ernst & Young put out a study that 

letting tax rates for the wealthiest Americans lapse would cost 

about 700,000 jobs, the exact same numbers basically, and I am not 

trying to compare apples and oranges. I think as one wise person 

said, we might be talking about red apples versus green apples 

here. But we have to look at that side of the equation as we are 

moving forward. 

The long term, I want to talk a little bit about that, and I have 

a specific question. On page 5, to quote your report today, ‘‘HowVerDate Nov 24 2008 16:58 Aug 02, 2013 Jkt 080869 PO 00000 Frm 00055 Fmt 6633 Sfmt 6633 K:\DOCS\80869.TXT TERRI
52 

ever, the committee remains—the committee being you all—confident that it has the tools necessary to tighten monetary policy 

when the time comes to do so,’’ and I know you have laid out 2015, 

2016, that timeframe. 

Exactly what tools do you believe that you are going to employ 

to put that restraint back in place? 

Mr. BERNANKE. We earlier discussed the exit sequence. So, first, 

we can simply allow securities on our balance sheet to run off and 

not replace them as we currently are doing. Second, we have a 

number of tools that can be used to drain reserves from the system, 

such as reverse repos. Third, we can raise interest rates even without reducing our balance sheet by raising the interest rate we pay 

on excess reserves which will in turn translate into higher interest 

rates in money markets. And fourth and finally, and it is not the 

first resort, but eventually we can sell the securities back into the 

market in a slow predictable way. 

Mr. HUIZENGA. This has not been done though, I think as we 

talked about with Japan and others, correct? This is the theory of 

how we are going to do this. 

Mr. BERNANKE. Each of the elements is something that we have 

tested, that we have seen other countries use, so we think we understand it pretty well. 

Mr. HUIZENGA. So the thing I did appreciate is you laid out three 

things that you wanted to have brought to light today, and interest 

rates won’t be this low forever was something I think we were not 

living with the reality of or the recognition of that. I am curious, 

because you talk about there, and I am afraid that the headlines 

tomorrow are going to be, ‘‘Bernanke blasts across-the-board cuts,’’ 

and/or, ‘‘Bernanke calls for a stoppage of the across-the-board cuts,’’ 

when frankly, based on what I read and what I have heard of the 

testimony today, I think the headlines ought to be, ‘‘Bernanke calls 

for long-term reforms.’’ And there is just a denial in this town in 

so many ways about what is happening now and in the future. 

What would you say to those who say we can’t or shouldn’t reform these long-term programs? 

Mr. BERNANKE. I don’t think we have any choice. I think I have 

tried throughout this discussion to always have two parts to the 

recommendation. 

Mr. HUIZENGA. You are a good economist. One hand or the other 

hand. 

Mr. BERNANKE. I have a third hand here, too. Anyway, with the 

idea being that we want to reduce somewhat the fiscal drag in 

2013. And I am not speaking only about the sequester. I talked 

about all of the fiscal actions which collectively are about 1.5 percentage points, according to the CBO. But I am not here to recommend that we just kick the can indefinitely down the road. I still 

think it is very important to address the long-range issues. 

Mr. HUIZENGA. We have about 10 seconds. So this is Medicare, 

Medicaid, Social Security reform? 

Mr. BERNANKE. The specifics are up to Congress, but obviously— 

Mr. HUIZENGA. Those are our long-term drivers of that. So there 

you go, folks. The headline for tomorrow is, ‘‘Bernanke calls for 

long-term fixes.’’ 

Chairman HENSARLING. The time of the gentleman has expired. 

53 

The Chair now recognizes the gentleman from Michigan, Mr. Kildee, for 5 minutes. 

Mr. KILDEE. Thank you, Mr. Chairman, and in respect for the 

time that Chairman Bernanke has provided us, I will ask one I 

think very important question, and then if allowable, yield the remainder of my time to my colleague, Mr. Ellison, to ask a question. 

Before I came to Congress, as I mentioned to you before the hearing, I was in local government. I was the county treasurer of Genesee County, Michigan, which is home to Flint, Michigan. We have 

seen recently over the last couple of years, but even in the last few 

weeks, a significant number of downgrades to municipal debt which 

by itself is an issue that I am interested in your thinking on, but 

I think also represents a symptom of a much larger problem, and 

that is municipal insolvency generally. We have seen Vallejo, California; Harrisburg, Pennsylvania; Camden, New Jersey; my own 

hometown of Flint, Michigan, and now we see Detroit facing this 

insolvency. 

The solutions, the State-based solutions to these problems typically have been replacing existing management with different management that can presumably make different decisions that result 

in outcomes that are more favorable. I think what we are facing, 

in my opinion, in my work across the country, is something much 

bigger than a failure of management but a structural failure in 

what I think is potentially another institutional failure in the 

urban setting, in municipal governments. 

I am interested in your thoughts about the implications for that 

trend, if you agree that it is taking place on our economy, what solutions the Federal Government might consider, if any, to deal with 

that. And then a corollary to that, to the extent that the sequester 

will disproportionately affect the most vulnerable of our citizens, 

isn’t it also logical to assume that the sequester cuts might exacerbate what is already a growing problem in urban America and 

make this insolvency even more difficult to manage? 

Mr. BERNANKE. The last few years have been a very tough time 

for State and local governments. Not only are income and sales 

taxes down, but so are property taxes as property values have come 

down as well. As a result, as I mentioned before, State and local 

governments have cut workforces, have cut spending, have cut capital projects. Some have been able to steady the ship. Others are 

still under a lot of stress. 

Obviously, in the short term trying to promote job creation as the 

Fed is trying to do and as I am asking the Congress to think about 

in their decisions is going to help a lot of these areas by creating 

more economic activity and more tax revenues. 

There are obviously some parts of the country where there are 

longer-term, more structural problems that are not just business 

cycle problems, and some of those may be in your State. There I 

don’t really have a solution. The Federal Government has not in 

the past involved itself that much with those distressed municipalities. 

Mr. KILDEE. I guess if I could just quickly follow up on that, the 

Federal Government hadn’t involved themselves in a lot of things 

until the necessity appeared. What I am concerned about the State 

governments may not have the capacity and the cities failing will 

54 

be a national problem one way or another. I suggest perhaps at a 

different juncture we might pursue some thought about how the 

Federal Government might intervene in that case. 

I would yield the remainder of my time to Mr. Ellison. 

Mr. ELLISON. Thank you, Mr. Kildee. I am very grateful. 

Chairman Bernanke, I don’t have much time so I am going to 

ask you straight, Sheila Bair had an article in today’s New York 

Times focusing on income inequality. My question to you is, does 

inequality matter in terms of the inefficiency and functioning and 

growth of our economy? 

Mr. BERNANKE. It is very important in its own right. We want 

everybody to have opportunities, we want a fair society. I think it 

does. If people don’t have—if talented people don’t have the ability 

to move up and get a good education and to move into the middle 

class, that that is a loss for everyone, not just for those individuals. 

So I think a society in which there is greater equality of opportunity will be a more productive and efficient society as well. 

Mr. ELLISON. Those points you made I think are absolutely right, 

but 70 percent of our economy is consumer spending. If folks on the 

bottom don’t have— 

Mr. BERNANKE. But in the longer term, what matters is our productive capacity. And there, human talent and skills are really the 

most important thing. In this country, we had a period where we 

brought women into the labor force, and that brought a whole new 

set of skills and talents into our economy. 

Chairman HENSARLING. The time of the gentleman has expired 

just under the wire. The last word will go to the gentleman from 

Wisconsin. Mr. Duffy is recognized for 5 minutes. 

Mr. DUFFY. Thank you, Mr. Chairman. And good afternoon, 

Chairman Bernanke. Yesterday in the Senate hearing, you had a 

conversation about some of your concerns about Dodd-Frank. You 

didn’t have much time to answer that question. Would you mind 

sending me in writing a little more detail on all of your concerns 

with Dodd-Frank, maybe, say, in 2 weeks? 

Mr. BERNANKE. Sure. But we don’t have a long list of specifics 

at this point. 

Mr. DUFFY. That is okay. 

Mr. BERNANKE. I do think it would be a good thing for Congress 

to review. 

Mr. DUFFY. But if you wouldn’t mind sending the Fed’s concerns, 

I would appreciate that. Is that okay? 

Mr. BERNANKE. Certainly. 

Mr. DUFFY. In 2 weeks? 

Mr. BERNANKE. That would be fine. 

Mr. DUFFY. 2 or 3 weeks? 

Mr. BERNANKE. As soon as we can. 

Mr. DUFFY. You have a big team. All right. Quickly, I want to 

talk about the debt. Roughly, we spend about, what, $225 billion 

a year to service our $16.5 trillion in debt. Is that right? Roughly? 

Mr. BERNANKE. Sounds about right. 

Mr. DUFFY. Okay. And for the CBO, for every additional point that our interest rates go up, it costs us an additional $100 billion 

a year to service the debt. Does that sound right? 

Mr. BERNANKE. Yes. 

55 

Mr. DUFFY. So if you stop with your accommodative monetary 

policy, we could see interest rates rise 2 or 3 percent, right? So we 

would have an additional $200 billion to $300 billion of additional 

dollars going to service our current debt. Is that fair to say? 

Mr. BERNANKE. That is right. CBO takes this into account in 

their projections. 

Mr. DUFFY. And so, for me, I look at that and say, listen, this is a half a trillion dollars a year to service our current debt, $5 trillion over 10 years. I look at this and I see the lights going off, the 

sirens are blaring, and I am almost setting a proverbial can on my 

counter and you are kicking it saying, listen, don’t worry about $85 

billion in cuts; do it a different day. 

I listened to what you are saying, and I think you are giving 

cover to a set of policies that aren’t responsible, and we are all 

going to pay the price for the fiscal irresponsibility. And instead of 

encouraging responsibility, you come in and say, listen, to cut 2 

percent of our budget, you can’t do it. It is going to have a great 

impact on our economy. Mr. Chairman, that doesn’t make sense to 

me. 

Mr. BERNANKE. I think most economists, including the CBO, 

would say that this will cost a lot of jobs in the short run, and you 

can address—you can achieve the same results with longer-term 

programs. 

Mr. DUFFY. And so on that point, how many jobs are lost if we cut the $27 million that go to Moroccan pottery classes or the $2.2 

billion in free cell phones? We pay $700 billion to see how long 

shrimp can run on a treadmill. I believe we paid for the travel expenses for the Watermelon Queen in Alabama. 

There is fat in the budget, and I think every American looks at 

how we spend our money and they say, I can cut 2 percent out of 

my family budget, small businesses can say, I can cut 2 percent out 

of my budget, but you come in and tell us, listen, I agree with the 

President. It is catastrophic, it is catastrophic if you cut 2 percent, 

mass mayhem in our economy, I find that to be unbelievable. 

Mr. BERNANKE. The sequester is not designed to cut wasteful 

stuff. It is across-the-board. 

Mr. DUFFY. So, then, are you here telling us that if we cut $85 

billion in a more reflective way in the bad spending that I just referenced, you would support it? It is a good idea if we are not doing 

it by way of the sequester, but we have a little more reflective analysis— 

Mr. BERNANKE. It would be better. 

Mr. DUFFY. —on the $85 billion? 

Mr. BERNANKE. It would be better. 

Mr. DUFFY. So is it better, or you would agree with us that we 

should actually reduce spending? 

Mr. BERNANKE. I am still concerned about the short-run impact 

on jobs. And you don’t get as much benefit as you think, because 

if you slow the economy, that hurts your revenues, and that means 

your deficit reduction is not as big as you think it is. 

Mr. DUFFY. So the revenues that we get from the Moroccan pot- tery classes, then, and the $2.2 billion in free cell phones, and the 

list goes on, Mr. Chairman, that is a great driver of economic 

growth in our country? Is that your position? 

56 

Mr. BERNANKE. Most of the spending goes to the military and to 

transfer programs like Social Security and Medicare. 

Mr. DUFFY. And there is a lot of fat and you can find 2 percent 

fat that doesn’t affect our military, doesn’t affect our— 

Mr. BERNANKE. I also said in my testimony that not all spending 

and taxes are the same. I very much advocate trying to make good 

decisions about how you tax and how you spend. 

Mr. DUFFY. So you agree there is fat and that you would encourage us to cut the fat, because if you weren’t interjecting your policy, 

this would be a half a trillion dollar expense to the American Government, almost what we spend on our military? 

Mr. BERNANKE. I think there is good—yes. It is obviously a good 

idea to improve or fiscal budgeting and to make better decisions, 

certainly. 

Mr. DUFFY. I know you like to say you stick to monetary policy, 

but you do come in here and you talk about fiscal policy all the 

time. And if you don’t like our approach to try and reduce how 

much we spend and you want to kick the can down the road, if— 

and I don’t have much time, 15 seconds—if you wouldn’t mind supplying in writing your plan for a long-term fiscal approach, I would 

appreciate that, because you keep—whenever we try to cut spending, you come at us and say, don’t cut spending today. No, no, no. 

Cut it tomorrow. If you have a better plan on how we can have a 

long-term approach to fix this problem, if you would submit that 

in writing, too, I would appreciate it, Mr. Chairman. Thank you. 

Mr. BERNANKE. You bet. 

Chairman HENSARLING. The time of the gentleman has expired. 

I would like to thank Chairman Bernanke for his testimony today. 

The Chair notes that some Members may have additional questions for this witness, which they may wish to submit in writing. 

Without objection, the hearing record will remain open for 5 legislative days for Members to submit written questions to this witness 

and to place his responses in the record. We would ask you, Chairman Bernanke, to please respond as promptly as you are able. 

Also, without objection, Members will have 5 legislative days to 

submit extraneous materials to the Chair for inclusion in the 

record. 

Without objection, the hearing is adjourned. 

[Whereupon, at 1:08 p.m., the hearing was adjourned.] 

(57) 

A P P E N D I X 

February 27, 2013 

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80869.001

THE HONORABLE DENNIS Ross (Fl-1S) 

229 Cannon House Office Building 

Washington, DC 20515 

Office: 202-225-1252 

http://dennisross.house.gov 

Committee on Financial Services 

Hearing: Monetary Policy and the State of the Economy 

February 27, 2013 

Statement for the Record 

Thank you Chairman Hensarling for holding this important hearing today, and thank you Chairman 

Bernanke for testifying before this committee. I take your opinions and the actions of the Federal 

Reserve Board (the Board) to heart. So again, thank you. 

If you are here to speak on the state of the economy, you cannot speak on the economy of my state 

without taking into consideration the deeply entangled role natural disasters and property/casualty 

insurance plays in it. Florida has more than twice the national average for foreclosure filings; one of 

every 706 housing units received some type of foreclosure filing in October 2012. Unfortunately though, 

while home values might be slowly increasing, so are insurance costs. The average premium for a 

homeowners' policy in 2002, prior to the four major hurricanes that crossed our state in 2004, was 

$786. In 2010, it was almost double that amount, $1,544 - which was the third highest in the nation. 

I have spent most of my life in Florida. I remember Hurricane Andrew, and how fearful my wife and I 

were when the property and casualty insurance market dried up and we were left without insurance 

coverage that was required by our mortgage lender. If you were to conSider that event today, it would 

prove disastrous to our state. If another hurricane were to hit six Florida counties (Broward, Dade, 

Hillsborough, Lee, Monroe and Palm Beach) and 5% of the businesses had to shut down, that would 

translate into the closure of nearly 2,500 business, lost sales of $3.8 billion, $81.8 million in lost sales tax 

receipts, $79.8 million in payroll losses and the loss of more than 30,000 jobs - and 5% was about only 

half of what Hurricane Andrew was in 1992. Insurance helps to mitigate the negative economic effects 

of natural disasters, and elected officials like myself must do everything in our power to ensure 

insurance is available and reflects the true costs of the market. 

I was also chair of the Insurance Committee in the Florida State Legislature after the disastrous 

hurricane seasons of '04 and 'OS. And I can tell you after all of those years of personal experience that 

with all due respect, you - as a federal regulator and Chair of the Federal Reserve Board, and the other 

governors who look at things from a bank-centric point of view - do not have the experience, foreSight, 

insight, or hindsight to make decisions affecting insurers in Florida. So to say I have grave concerns over 

the Board's proposed rules coming out of Basel III regarding capital requirements for insurance 

companies is a drastic understatement. 
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80869.002

Simply put: these bank-centric rules for minimum leverage and risked-based capital requirements are 

wrong for companies whose primary business comes from selling insurance products, regardless of 

whether they have a saving and loan holding company (SLHC) or not. Moreover, insurance companies 

selling auto, health, life, property and casualty, even surplus lines policies are not even subjected to the 

same capital requirements, much less the same across the country. The fact is, capital requirements 

should be determined by the state in which the insurance company is domiciled should be the minimum 

-period. 

As Florida Insurance Commissioner and President of the National Association of Insurance Commissioner 

Kevin McCarty stated when he testified at a field hearing last year: 

"Insurance has shorter duration liabilities in many of the property/casualty and health 

product lines, and the assets held are similarly short-term. Insurance has longer 

duration liabilities in life and annuity product lines, and these liabilities are matched 

against longer-term assets. This is a critical distinction from banking and other financial 

products. The reason many other financial firms suffered during the financial crisis was 

that the duration of their assets and liabilities were not matched in a way that enabled 

them to fund their liabilities when they came due ... It is for this reason that insurance 

regulators purposely avoid a 'one-size-fits-all' approach and, instead, opt for company 

and product specific analysis and examination." 

Another explanation comes from a representative of the American Council of Ufe Insurers: 

"Banks rely on short term, on-demand funding that can put pressure on liquidity in 

times of stress. Ufe insurers are much less likely to experience a 'run on the bank' 

liquidity event because their products are long-term and do not have an immediate call 

ability." 

What troubles me most about the Board's proposed capital requirements is the claim by one insurance 

company I spoke with that stated that under some scenarios, an insurance-based SLHC could be subject 

to seizure levels under a state regulator but would look well-capitalized under a Basel "consolidated" 

framework. Florida cannot take this gamble on the viability of the insurance providers the Board rules 

are suggesting. Hundreds of years of natural disasters, an aging population, a housing boom, and a 

fickle economy have taught us that. 

My second concern regarding the Board's proposed rule is the new requirement that insurance 

companies will be required to follow Generally Accepted Accounting Principles (GAAP) instead of 

Statuary Accounting Procedures (SAP). Today, mutual insurance companies are required to file financial 

statements based on SAP principles by their state regulators that were designed by them to assist them 

in monitoring the solvency of an insurer. GAAP accounting principles were designed to provide key 

information to investors of public companies to look at ongoing concerns. Therefore, the assets, 

liabilities, and surplus reported in statutory financial statements under SAP are typically much more 

conservative than under GAAP. 

Honorable Dennis Ross (FL-lS) Page 2 
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Additionally, one of the largest insurance companies in Florida stated they expect it will take four years 

to implement the GAAP filing requirements that will be in addition to the SAP filings the state will still 

require and cost $150 million a year to comply - and these costs will be placed squarely on the backs of 

policyholders in my state. As I previously stated, Floridians are already paying some of the highest 

premiums in the country that have doubled over the past five years. This is not the time to increase 

costs for insurance premiums - especially when the Board will not learn any new, helpful financial 

information from the GAAP filings. 

Finally, I reiterate the claims and concerns of others that a rule of this nature is not only violating 

McCarran-Ferguson, it is blatantly ignoring Congressional intent under the Dodd-Frank Act. Not even 

amendment-writer and sponsor Senator Collins believes the Board is right. Under the Collins 

Amendment, the Board is directed to set minimum capital requirements for depository institution 

holding companies, but the amendment does not preclude the Board from taking into account the 

existing and comprehensive requirements under state jurisdiction. Nor does Dodd-Frank suggest any 

such limitation. She and other Members of Congress understood very clearly the simple reality that you 

cannot regulate banks and insurance in the same way. I do not understand why the Board is having such 

trouble understanding that as well. 

Furthermore, the McCarran-Ferguson Act prohibits Congress from getting into the business of regulating 

insurance. Without a clearly expressed Congressional directive, the Board's proposed rule runs the risk 

of legal challenges under McCarran-Ferguson that could result in years of litigation battles and increased 

costs for policyholders. Again, this is not the time to dump that kind of burden on families in Florida. 

I recognize that the Board is attempting - at the direction of Congress - to ensure that a collapse of an 

AIG-nature never happens again, and I truly applaud you for your efforts. However, as I continue to 

watch this process unfold, my opinion is that the Board is searching the past for problems to their 

solutions proposed under this rule. The Board is building a system to combat the last crisis, but I am not 

confident that had any of these rules been in place a decade ago they would have caught or prevented 

the AIG collapse a collapse that is still partly to blame for the underwhelming economic outlook you 

will be presenting today, Chairman Bernanke. 

I firmly believe that instead of taking away the power of the state regulators and proven, effective state 

requirements, requiring onerous and costly regulatory burdens, and even possibly violating current 

federal law as the Board proposes, there is a better approach. The approach the Board could take 

should work to actually reduce systemic risk instead of merely accepting it and forcing others who 

played no part in the economic situation we are in today to mitigate for it. 

Thank you Mr. Chairman, and Chairman Bernanke, for hearing my concerns, and I look forward to your 

testimony. 

Honorable Dennis Ross (Fl-1S) Page 3 
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80869.004

For release on delivery 

10:00 a.m. EDT 

February 27,2013 

Statement by 

Ben S. Bemankc 

Chainnan 

Board of Govemors of the Federal Reserve System 

before the 

Committee on Financial Services 

u.s. House of Representatives 

February 27, 2013 
62 


80869.005

Chairman Hensarling, Ranking Member Waters, and other members of the Committee, I 

am pleased to present the Federal Reserve's semiannual MonetaJY Policy Report. I will begin 

with a short summary of current economic conditions and then discuss aspects of monetary and 

fiscal policy. 

Curreut Ecouomic Conditions 

Since I last reported to this Committee in mid-2012, economic activity in the United 

States has continued to expand at a moderate if somewhat uneven pace. In particular, real gross 

domestic product (GDP) is estimated to have risen at an annual rate of about 3 percent in the 

third quarter but to have been essentially flat in the fourth quarter. 1 The pause in real GDP 

growth last quarter does not appear to reflect a stalling-out of the recovery. Rather, economic 

activity was temporarily restrained by weather-related disruptions and by transitory declines in a 

few volatile categories of spending, even as demand by U.S. households and businesses 

continued to expand. Available information suggests that economic growth has picked up again 

this year. 

Consistent with the moderate pace of economic growth, conditions in the labor market 

have been improving gradually. Since July, nonfarm payroll employment has increased by 

175,000 jobs per month on average, and the unemployment rate declined 0.3 percentage point to 

7.9 percent over the same period. Cumulatively, private-sector payrolls have now grown by 

about 6.1 million jobs since their low point in early 20 I 0, and the unemployment rate has fallen a 

bit more than 2 percentage points since its cyclical peak in late 2009. Despite these gains, 

however, the job market remains generally weak, with the unemployment rate well above its 

longer-run normal level. About 4.7 million of the unemployed have been without ajob for six 

I Data for the fourth quarter of 20 12 from the national income and product accounts reflect the advance estimate 

released on January 30, 20]3. 
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80869.006

- 2 -

months or more, and millions more would like full-time employment but are able to find only 

part-time work. High unemployment has substantial costs, including not only the hardship faced 

by the unemployed and their families, but also the harm done to the vitality and productive 

potential of our economy as a whole. Lengthy periods of unemployment and underemployment 

can erode workers' skills and attachment to the labor force or prevent young people from gaining 

skills and experience in the first place--developments that could significantly reduce their 

productivity and earnings in the longer term. The loss of output and earnings associated with 

high unemployment also reduces government revenues and increases spending, thereby leading 

to larger deficits and higher levels of debt. 

The recent increase in gasoline prices, which reflects both higher crude oil prices and 

wider refining margins, is hitting family budgets. However, overall inflation remains low. Over 

the second half of 20 12, the price index for personal consumption expenditures rose at an annual 

rate of 1-112 percent, similar to the rate of increase in the first half of the year. Measures of 

longer-term inflation expectations have remained in the narrow ranges seen over the past several 

years. Against this backdrop, the Federal Open Market Committee (FOMC) anticipates that 

inflation over the medium term likely will run at or below its 2 percent objective. 

Monetary Policy 

With unemployment well above normal levels and inflation subdued, progress toward the 

Federal Reserve's mandated objectives of maximum employment and price stability has required 

a highly accommodative monetary policy. Under normal circumstances, policy accommodation 

would be provided through reductions in the FOMC's target for the federal funds rate--the 

interest rate on overnight loans between banks. However, as this rate has been close to zero 

since December 2008, the Federal Reserve has had to use alternative policy tools. 
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80869.007

- 3 -

These alternative tools have fallen into two categories. The first is "forward guidance" 

regarding the FOMe's anticipated path for the federal funds rate. Since longer-term interest 

rates reflect market expectations for shorter-term rates over time, our guidance influences longertenn rates and thus supports a stronger recovery. The formulation of this guidance has evolved 

over time. Between August 2011 and December 2012, the Committee used calendar dates to 

indicate how long it expected economic conditions to warrant exceptionally low levels for the 

federal funds rate. At its December 2012 meeting, the FOMC agreed to shift to providing more 

explicit guidance on how it expects the policy rate to respond to economic developments. 

Specifically, the December postmeeting statement indicated that the current exceptionally low 

range for the federal funds rate "will be appropriate at least as long as the unemployment rate 

remains above 6-112 percent, inflation between one and two years ahead is projected to be no 

more than a half percentage point above the Committee's 2 percent longer-run goaL and longerterm inflation expectations continue to be well anchored."z An advantage of the new 

formulation, relative to the previous date-based guidance, is that it allows market participants 

and the public to update their monetary policy expectations more accurately in response to new 

information about the economic outlook. The new guidance also serves to underscore the 

Committee's intention to maintain accommodation as long as needed to promote a stronger 

economic recovery with stable prices. 3 

2 See Board of Governors of the Federal Reserve System (2012), "Federal Reserve Issues FOMC Statement," press 

release, December 12, www.federalreserve.gov/newsevents/press/monetary/20121212a.htm. 

3 The numerical values for unemployment and inflation included in the guidance are thresholds, not triggers; that is, 

depending on economic circumstances at the time, the Committee may judge that it is not appropriate to begin 

raising its target for the federal funds rate as soon as one or both of the thresholds is reached. The 6-1/2 percent 

threshold for the unemployment rate should not be interpreted as the Committee's longer-term objective for 

unemployment; because monetary policy affects the economy with a lag, (he first increase in the target for the funds 

rate will likely have to occur when the unemployment rate is still above its longer-run normalleve\. Likewise, the 

Committee has not altered its longer-run goal for inflation of2 percent, and it neither seeks nor expects a persistent 

increase in inflation above that target. 
65 


80869.008

-4-

The second type of nontraditional policy tool employed by the FOMC is large-scale 

purchases of longer-term securities, which, like our forward guidance, are intended to support 

economic growth by putting downward pressure on longer-term interest rates. The Federal 

Reserve has engaged in several rounds of such purchases since late 2008. Last September the 

FOMC announced that it would purchase agency mortgage-backed securities at a pace of 

$40 billion per month, and in December the Committee stated that, in addition, beginning in 

January it would purchase longer-term Treasury securities at an initial pace of $45 billion per 

month. 4 These additional purchases oflonger-term Treasury securities replace the purchases we 

were conducting under our now-completed maturity extension program, which lengthened the 

maturity of our securities portfolio without increasing its size. The FOMC has indicated that it 

will continue purchases until it observes a substantial improvement in the outlook for the labor 

market in a context of price stability. 

The Committee also stated that in determining the size, pace, and composition of its asset 

purchases, it will take appropriate account of their likely efficacy and costs. In other words, as 

with all of its policy decisions, the Committee continues to assess its program of asset purchases 

within a cost-benefit framework. In the current economic environment, the benefits of asset 

purchases, and of policy accommodation more generally, are clear: Monetary policy is 

providing important support to the recovery while keeping inflation close to the FOMe's 

2 percent objective. Notably, keeping longer-term interest rates low has helped spark recovery in 

the housing market and led to increased sales and production of automobiles and other durable 

goods. By raising employment and household wealth--for example, through higher home 

prices--these developments have in turn supported consumer sentiment and spending. 

4 See Board of Governors of the Federal Reserve System (2012), "Federal Reserve Issues FOMC Statement," press 

reJease, September 13, www.federalreserve.gov/newsevents/press/monetary120120913a.htm; and Board of 

Governors, "FOMC Statement," December 12, in note 2. 
66 


80869.009

- 5 -

Highly accommodative monetary policy also has several potential costs and risks, which 

the Committee is monitoring closcly. For example, if further expansion of the Federal Reserve's 

balance sheet were to undermine public confidence in our ability to exit smoothly from our 

accommodative policies at the appropriate time, inflation expectations could rise, putting the 

FOMe's price-stability objective at risk. However, the Committee remains confident that it has 

thc tools necessary to tighten monetary policy when the time comes to do so. As I noted, 

intlation is currently subdued, and inflation expectations appear well anchored; neither the 

FOMC nor private forecasters are projecting the development of significant intlation pressures. 

Another potential cost that the Committee takes very seriously is the possibility that very 

low interest rates, if maintained for a considerable time, could impair financial stability. For 

example, portfolio managers dissatisfied with low returns may "reach for yield" by taking on 

more credit risk, duration risk, or leverage. On the other hand, some risk-taking--such as when 

an entrepreneur takes out a loan to start a new business or an existing firm expands capacity--is a 

necessary element of a healthy economic recovery. Moreover, although accommodative 

monetary policies may increase certain types of risk-taking, in the present circumstances they 

also serve in some ways to reduce risk in the system, most importantly by strengthening the 

overall economy, but also by encouraging firms to rely more on longer-term funding, and by 

reducing debt service costs for households and businesses. In any case, the Federal Reserve is 

responding actively to financial stability concerns through substantially expanded monitoring of 

emerging risks in the financial system, an approach to the supervision of financial firms that 

takes a more systemic perspective, and the ongoing implementation of reforms to make the 

financial system more transparent and resilient. Although a long period of low rates could 

encourage excessive risk-taking, and continued close attention to such developments is certainly 
67 


80869.010

- 6-

warranted, to this point we do not see the potential costs ofthc increased risk-taking in some 

financial markets as outweighing the benefits of promoting a stronger economic recovery and 

more-rapid job creation. 5 

Another aspect of the Federal Reserve's policies that has been discussed is their 

implications for the federal budget. The Federal Reserve earns substantial interest on the assets 

it holds in its portfolio, and, other than the amount needed to fund our cost of operations, all net 

income is remitted to the Treasury. With the expansion ofthe Federal Reserve's balance sheet, 

yearly remittances have roughly tripled in recent years, with payments to the Treasury totaling 

approximately $290 billion between 2009 and 2012. 6 However, if the economy continues to 

strengthen, as we anticipate, and policy accommodation is accordingly reduced, these 

remittances would likely decline in coming years. Federal Reserve analysis shows that 

remittances to the Treasury could be quite low for a time in some scenarios, particularly if 

interest rates were to rise quickly.7 However, even in such scenarios, it is highly likely that 

average annual remittances over the period affected by the Federal Reserve's purchases will 

remain higher than the pre-crisis nonn, perhaps substantially so. Moreover, to the extent that 

monetary policy promotes growth and job creation, the resulting reduction in the federal deficit 

would dwarf any variation in the Federal Reserve's remittances to the Treasury. 

5 The Federal Reserve is also monitoring financial markets to ensure that asset purchases do not impair their 

functioning. 

6 See Board of Govemors oflhe Federal Reserve System (2013), "Reserve Bank Income and Expense Data and 

Transfers to the Treasury for 2012," press release, January 1 0, 

www.fedcralreserve.gov/newsevents/press/other/20130IIOa.htm. 

7 See Carpenter, Seth B., Jane E. Ihrig, Elizabeth C. Klee, Daniel W. Quinn, and Alexander H. Boote (2013), "The 

Federal Reserve's Balance Sheet and Earnings: A Primer and Projections," Finance and Economics Discussion 

Series 2013-01 (Washington: Federal Reserve Board, January), available at 

ht!p:llwww.federalreserve.gov/pubs/feds/2013/201301120 130 I pap.pdf. 
68 


80869.011

7 

Thoughts on Fiscal Policy 

Although monetary policy is working to promote a more robust recovery, it cannot carry 

the entire burden of ensuring a speedier return to economic health. The economy's performance 

both over the near term and in the longer run will depend importantly on the course of fiscal 

policy. The challenge for the Congress and the Administration is to put the federal budget on a 

sustainable long-run path that promotes economic growth and stability without unnecessarily 

impeding the current recovery. 

Significant progress has been made recently toward reducing the federal budget deficit 

over the next few years. The projections released earlier this month by the Congressional Budget 

Office (CBO) indicate that, under current law, the federal deficit will narrow from 7 percent of 

GOP last year to 2-1/2 percent in fiscal year 2015. 8 As a result, the federal debt held by the 

public (including that held by the Federal Reserve) is projected to remain roughly 75 percent of 

GOP through much of the current decade. 

However, a substantial portion of the recent progress in lowering the deficit has been 

concentrated in near-term budget changes, which, taken together, could create a significant 

headwind for the economic recovery. The CBO estimates that deficit-reduction policies in 

current law will slow the pace ofreal GOP growth by about 1-112 percentage points this year, 

relative to what it would have been otherwise. A significant portion of this effect is related to the 

automatic spending sequestration that is scheduled to begin on March 1, which, according to the 

CBO's estimates, will contribute about 0.6 percentage point to the fiscal drag on economic 

growth this year. Given the still-moderate underlying pace of economic growth, this additional 

near-term burden on the recovery is significant. Moreover, besides having adverse effects on 

8 See Congressional Budget Office (2013), The Budget and Economic Outlook: Fiscal Years 2013 to 2023 

(Washington: CBO. February), available at www.cbo.gov/publicationl43907. 
69 


80869.012

- 8 -

jobs and incomes, a slower recovery would lead to less actual deficit reduction in the short run 

for any given set of fiscal actions. 

At the same time, and despite progress in reducing near-term budget deficits, the difficult 

process of addressing longer-term fiscal imbalances has only begun. Indeed, the CBO projects 

thaI the federal deficit and debt as a percentage of GOP will begin rising again in the latter part 

of this decade, reflecting in large part the aging of the population and fast-rising health-care 

costs. To promote economic growth in the longer tenn, and to preserve economic and financial 

stability, fiscal policymakers will have to put the federal budget on a sustainable long-run path 

that first stabilizes the ratio of federal debt to GOP and, given the current elevated level of debt, 

eventually places that ratio on a downward trajectory. Between 1960 and the onset of the 

financial crisis, federal debt averaged less than 40 percent of GOP. This relatively low level of 

debt provided the nation much-needed flexibility to meet the economic challenges of the past 

few years. Replenishing this fiscal capacity will give future Congresses and Administrations 

greater scope to deal with unforeseen events. 

To address both the ncar- and longer-term issues, the Congress and the Administration 

should consider replacing the sharp, frontloaded spending cuts required by the sequestration with 

policies that reduce the federal deficit more gradually in the near term but more substantially in 

the longer run. Such an approach could lessen the near-term fiscal headwinds facing the 

recovery while more effectively addressing the longer-term imbalances in the federal budget. 

The sizes of deficits and debt matter, of course, but not all tax and spending programs are 

created equal with respect to their effects on the economy. To the greatest extent possible, in 

their efforts to achieve sound public finances, fiscal policymakers should not lose sight of the 

need for federal tax and spending policies that increase incentives to work and save, encourage 
70 


80869.013

- 9-

investments in workforce skills, advance private capital formation, promote research and 

development, and provide necessary and productive public infrastructure. Although economic 

growth alone cannot eliminate federal budget imbalances, in either the short or longer term, a 

more rapidly expanding economic pie will ease the difficult choices we face. 
71 


80869.014

LETTER OF TRANSMITTAL 

BOARD OF GOVERNORS OF THE 

FEDERAL RESERVE SYSTEM 

Washington, D.C., February 26, 2013 

THE PRESlDENT OF THE SENATE 

THE SPEAKER OF THE HOGSE OF REPRESENTATIVES 

The Board of Governors is pleased to submit its Monetary Policy Report pursuant to 

section 2 B of the Federal Reserve Act. 

Sincerely, 

~"e::-
72 


80869.015

CONTENTS 

Summary .......................................................... . 1 

Part 1 

Recent Economic and Financial Developments .. . . . . . . . . . . . . . . . . . . . . . . . .. 5 

Domestic Developments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 5 

Financial Developments. . . . . . . . .. . ...................................... 22 

International Developments ............................................... 29 

Part 2 

Monetary Policy ......................................................... 37 

Part 3 

Summary of Economic Projections ....................................... 43 

The Outlook for Economic Activity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . .. 45 

The Outlook for Inflation .................................................. 47 

Appropriate Monetary Policy .............................................. 52 

Uncertainty and Risks .................................................... 53 

Abbreviations ........................................................... 59 

List of Boxes 

Statement on Longer-Run Goals and Monetary Policy Strategy. . . . . . . . . . . . . . . .. 3 

Assessing Conditions in the Labor Market. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. 8 

The Federal Reserve's Actions to Foster Financial Stability ..................... 30 

An Update on the European Fiscal and Banking Crisis ....................... 32 

Efficacy and Costs of Large-Scale Asset Purchases ........................... 39 

Forecast Uncertainty ................................................. 57 
73 


80869.016

SUMMARY 

The US. economy continued to expand at a 

moderate rate, on average, over the second half 

of 2012. The housing recovery appeared to 

gain additional traction, consumer spending 

rose moderately, and business investment 

advanced further. Financial conditions eased 

over the period but credit remained tight for 

many households and businesses, and concerns 

about the course of federal fiscal policy 

and the ongoing European situation likely 

restrained private-sector demand. In addition, 

total government purchases continued to 

move lower in an environment of budget 

restraint, while export growth was held back 

by slow foreign economic growth. All told, real 

gross domestic product (GDP) is estimated 

to have increased at an average annual rate 

of I y, percent in the second half of the year, 

similar to the pace in the first half. 

Conditions in the labor market gradually 

improved. Employment increased at an 

average monthly pace of 175,000 in the 

second half of the year, about the same as in 

the first half. The unemployment rate moved 

down from 8\4 percent last summer to a 

little below 8 percent in January. Even so, 

the unemployment rate was still well above 

levels observed prior to the recent recession. 

Moreover, it remained the case that a large 

share of the unemployed had been out of 

work for more than six months, and that a 

significant portion of the employed had parttime jobs because they were unable to find fulltime employment. Meanwhile, consumer price 

inflation remained subdued amid stable longterm inflation expectations and persistent slack 

in labor markets. Over the second half of the 

year, the price index for personal consumption 

expenditures increased at an annual rate of 

1 ~ percent. 

During the summer and fall, the Federal Open 

Market Committee (FOMC) judged that the 

economic recovery would strengthen only 

gradually over time, as some of the factors 

restraining activity-including restrictive credit 

for some borrowers, continuing concerns about 

the domestic and international economic 

environments, and the ongoing shift toward 

tighter federal fiscal policy-were thought 

likely to recede only slowly. Moreover, the 

Committee judged that the possibility of an 

escalation of the financial crisis in Europe and 

uncertainty about the course of fiscal policy in 

the United States posed significant downside 

risks to the outlook for economic activity. 

However, the Committee expected that, 

with appropriate monetary accommodation, 

economic growth would proceed at a moderate 

pace, with the unemployment rate gradually 

declining toward levels consistent with 

the FOMe's dual mandate of maximum 

employment and price stability. Against 

this backdrop, and with long-run inflation 

expectations well anchored, the FOMC 

projected that inflation would remain at or 

below the rate consistent with the Committee's 

dual mandate. 

Accordingly, to promote its objectives, 

the FOMC provided additional monetary 

accommodation during the second half 

of 2012 by both strengthening its forward 

guidance regarding the federal funds rate 

and initiating additional asset purchases. In 

September, the Committee announced that 

it would continue its program to extend the 

average maturity of its Treasury holdings and 

would begin purchasing additional agencyguaranteed mortgage-backed securities (MBS) 

at a pace of $40 billion per month. The 

Committee also stated its intention to continue 

its purchases of agency MBS, undertake 

additional asset purchases, and employ 

its other policy tools as appropriate until 

the outlook for the labor market improves 

substantially in a context of price stability. The 

Committee agreed that in determining the size, 

pace, and composition of its asset purchases, 
74 


80869.017

2 SUMMARY 

it would, as always, take account of the likely 

efficacy and costs of such purchases. The 

Committee also modified its forward guidance 

regarding the federal funds rate at the 

September meeting, noting that exceptionally 

low levels for the federal funds rate were 

likely to be warranted at least through mid2015, longer than had been indicated in 

previous FOMC statements. Moreover, the 

Committee stated its expectation that a highly 

accommodative stance of monetary policy 

would remain appropriate for a considerable 

time after the economic recovery strengthens. 

In December, the Committee announced 

that in addition to continuing its purchases 

of agency MBS, it would purchase longerterm Treasury securities, initially at a pace 

of S45 billion per month, starting after the 

completion at the end of the year of its 

program to extend the maturity of its Treasury 

holdings. It also further modified its forward 

rate guidance, replacing the earlier date-based 

guidance with numerical thresholds for the 

unemployment rate and projected inflation. 

In particular, the Committee indicated that it 

expected the exceptionally low range for the 

federal funds rate would remain appropriate 

at least as long as the unemployment rate 

remains above 6;;' percent, inflation between 

one and two years ahead is projected to be 

no more than :12 percentage point above the 

Committee's 2 percent longer-run goal, and 

longer-term inflation expectations continue to 

be well anchored. 

Partly in response to this additional monetary 

accommodation, as well as to improved 

sentiment regarding the situation in Europe, 

broad financial conditions eased over the 

second half of 2012. Although yields on 

nominal Treasury securities rose, on net, yields 

on inflation-protected Treasury securities 

declined, and longer-term interest rates 

paid by households and firms generally fell. 

Yields on agency MBS and investment- and 

speculative-grade corporate bonds touched 

record lows, and broad eq nity price indexes 

rose. Conditions in short-term dollar funding 

markets eased over the summer and remained 

stable thereafter, and market sentiment toward 

the banking industry improved. Nonetheless, 

credit remained tight for borrowers with lower 

credit scores, and borrowing conditions for 

small businesses continued to improve more 

gradually than for large firms. 

At the time of the most recent FOMe 

meeting in January, Committee participants 

saw the economic outlook as little changed 

or modestly improved from the time of their 

December meeting, when the most recent 

Summary of Economic Projections (SEP) was 

compiled. (The December SEP is included as 

Part 3 of this report.) Participants generally 

judged that strains in global financial markets 

had eased somewhat, and that the downside 

risks to the economic outlook had lessened. 

Under the assumption of appropriate 

monetary policy-that is, policy consistent 

with the Committee's Statement on LongerRun Goals and Monetary Policy Strategy 

(see box)-FOMC participants expected the 

economy to expand at a moderate pace, with 

the unemployment rate gradually declining 

and inflation remaining at or below the 

Committee's 2 percent longer-run goal. 
75 


80869.018

MONETARY POLICY REPORT, fEBRUARY 2013 3 

Statement on longer-Run Goals and Monetary Policy Strategy 

As amended effective on January 29, 2013 

The Federal Open Market Committee (FOMC) 

is firmly committed to fulfilling its statutory 

mandate from the Congress of promoting maximum 

employment, stable prices, and moderate long-term 

interest rates. The Committee seeks to explain its 

monetary policy decisions to the public as clearly 

as possible. Such darity faei litates well-informed 

decisionmaking by households and businesses, 

reduces economic and financial uncertainty, increases 

the effectiveness of monetary policy, and enhances 

transparency and accountability, which are essential in 

a democratic society. 

inflation, employment, and long-term interest 

rates fluctuate over time in response to economic and 

financial disturbances. Moreover, monetary policy 

actions tend to influence economic activity and prices 

with a lag. Therefore, the Committee's policy decisions 

reflect its longer-run goals, its medium-term outlook, 

and its assessments of the balance of risks, including 

risks to the financial system that could impede the 

attainment of the Committee's goals. 

The inflation rate over the longer run is primarily 

determined by monetary policy, and hence the 

Committee has the ability to specify a longer-run 

goal for inflation. The Committee judges 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. 

Communicating this inflation goal clearly to the 

public helps keep longer-term inflation expectations 

firmly anchored, thereby fostering price stability 

and moderate long-term interest rates and enhancing 

the Committee's ability to promote maximum 

employment in the face of significant economic 

disturbances. 

The maximum level of employment is largely 

determined by nonmonetary factors that affect the 

structure and dynamics of the labor market. These 

factors may change over time and may not be 

directly measurable. Consequently, it would not be 

appropriate to specify a fixed goal for employment; 

rather, the Committee's policy decisions must be 

informed by assessments of the maximum level of 

employment, recognizing that such assessments are 

necessarily uncertain and subject to revision, The 

Committee considers a wide range of indicators 

in making these assessments. Information about 

Committee participants' estimates of the longer-run 

normal rates of output growth <lnd unemployment is 

published four times per year in the FaMe's Summary 

of Economic Projections. For example, in the most 

recent projections, FOMC participants' estimates of the 

longer-run normal rate of unemployment had a central 

tendency of 5.2 percent to 6.0 percent, unchanged 

from one year ago but substantially higher than the 

corresponding interval several years earlier. 

In setting monetary poliCY, the Committee seeks 

to mitigate deviations of inflation from its longerrun goa I and deviations of employment from the 

Committee's assessments of its maximum level. These 

objectives are generally complementary. However, 

under circumstances in which the Committee judges 

that the objectives are not complementary, it follows 

a balanced approach in promoting them, taking 

into account the magnitude of the deviations and 

the potentially different time horizons over which 

employment and inflation are projected to return to 

levels judged consistent with its mandate. 

The Committee intends to reaffirm these principles 

and to make adjustments as appropriate at its annual 

organizational meeting each January. 
76 


80869.019

PART 1 

RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

Real gross domestic product (GOP) increased at a moderate annual rate of 1 V2 percent, on average, 

in the second half of 20l2-similar to the rate of increase in the first half-as various headwinds 

continued to restrain growth. Financial conditions eased over the second half in response to the 

additional monetary accommodation provided by the Federal Open Market Committee (FOMC) 

and to improved sentiment regarding the crisis in Europe. However, credit availability remained tight 

for many households and businesses. In addition, declines in real government purchases continued 

to weigh on economic activity, as did household and business concerns about the economic 

outlook, while weak foreign demand restrained exports. In this environment, conditions in the labor 

market continued to improve gradually but remained weak. At a little under 8 percent in January, 

the unemployment rate was still well above levels prevailing prior to the recent recession. Inflation 

remained subdued at the end of last year, with consumer prices rising at about a 1 V2 percent annual 

rate in the second half, and measures of longer-run inflation expectations remained in the narrow 

ranges seen over the past several years. 

Domestic Developments 

GOP increased moderately but continued 

to be restrained by various headwinds 

Real GDP is estimated to have increased 

at an annual rate of 3 percent in the third 

quarter but to have been essentially fiat in the 

fourth, as economic activity was temporarily 

restrained by weather-related disruptions and 

declines in some erratic categories of spending, 

including inventory investment and federal 

defense spending.' On average, real GDP 

expanded at an annual rate of I';' percent in 

the second half of 2012, similar to the pace of 

increase in the first half of the year (figure 1). 

The housing recovery gained additional 

traction, consumer spending continued to 

increase moderately, and business investment 

rose further. However, a severe drought 

1. Change in real gross domestic product, 2006--12 

l'ercent,annualrJle 

------

H2 

II I ilil 

I -2 

I I 2006 2007 2008 2009 2010 2011 2012 

5 

in much of the country held down farm 

production, and disruptions from Hurricane 

Sandy also likely held back economic activity 

somewhat in the fourth quarter. More 

fundamentally, some of the same factors 

Non" Here and 10 subsequent figures, except as noted, change for a given 

penod is measured to its final quarter from the final quaner of the preceding 

period 

that restrained growth in the first half of last 

year likely continued to weigh on activity. 

Although financial conditions continued to 

I. Data for the fourth quarter of 2012 from the 

national income and product accounts reflect the advance 

estimate released on January 30, 2013. 

SotJRCE: Department of Commerce, Bureau of Economic Analysis. 
77 


80869.020

6 PART 1; RECENT ECONOMIC AND fiNANCIAL DEVElOPMENTS 

2. Net change in payroll employment, 2006-13 

-~ 400 

200 

200 

400 

800 

LL ____ J __ ""~_L I I -LJ 2006 2007 2008 2009 2010 2011 2012 2013 

The data arc thrce~month moving averages and cxtend through 

Department of Labor, Bureau of Labor Statistics. 

3. Civilian unemployment rate, 1979-2013 

Percent 

12 

LLLLLLLU.l.lJ..l.l.lJ.Jl..LU.1 I! ! j I I I I I LUJ-LLJ 

19RJ 1989 1997 2005 2013 

l'on:: The data arc monthly and extend through January 2013, 

SO\!RCE: Department of Labor, Bureau of Labor Statistics 

4. Long~term unemployed, 1979-2013 

Percent 

50 

40 

30 

20 

10 

L.1...LuLLJ.' I I I ! I I 1 I I I 1 I UJJ_I I ! r I ! I I I I I I I 

1981 1989 1997 2005 2013 

The data afC monthly and extend through January 2013. The series 

shown the percentage of total unemployed persons who have been 

unemployed for 27 weeks or more 

SOURCE: Department of Labor, Bureau of Labor StatIstics. 

improve overall, the financial system has not 

fully recovered from the financial crisis, and 

banks remained cautious in their lending to 

many households and businesses. In particular, 

restricted financing for home mortgages 

and new-home construction projects, along 

with the depressing effects on housing 

demand of an uncertain outlook for house 

prices and jobs, kept the level of activity in 

the housing sector well below longer-run 

norms. Budgetary pressures at all levels of 

government also continued to weigh on GDP 

growth. Moreover, businesses and households 

remained concerned about many aspects of 

the economic environment, including the 

uncertain course of U.S. fiscal policy at the 

turn of the year as well as the still-worrisome 

European situation and the slow recovery 

more generally_ 

The labor market improved somewhat, 

but the unemployment rate remained 

high 

In this economic environment, firms increased 

their workforces moderately. Over the second 

half of last year, nonfarm payroll employment 

rose an average of about 175,000 per month, 

similar to the average increase in the first 

half (figure 2)_ These job gains helped lower 

the unemployment rate from 82 percent in 

the second quarter of last year to 7.9 percent 

in January (figure 3). Nevertheless, the 

unemployment rate remained much higher 

than it was prior to the recent recession, 

and long-term unemployment continued to 

be widespread. In the fourth quarter, about 

40 percent of the unemployed had been out 

of work for more than six months (figure 4). 

Moreover, the proportion of workers 

employed part time because they were unable 

to find full-time work remained elevated_ Some 

of the increase in the unemployment rate since 

the begiuning of the recent recession could 

reflect structural changes in the labor markelsuch as a greater mismatch between the types 

of jobs that are open and the skills of workers 

available to fill them-that would reduce the 

maximum sustainable level of employment. 

However, most of the economic analysis 
78 


80869.021

on this subject suggests that the bulk of the 

increase in unemployment probably reflects a 

deficiency in labor demand.' As a result, the 

unemployment rate likely remains well above 

levels consistent with maximum sustainable 

employment. 

As described in the box "Assessing Conditions 

in the Labor Market," the unemployment 

rate appears to be a very good indicator of 

labor market conditions. That said, other 

indicators also provide important perspectives 

on the health of the labor market, and the 

most accnrate assessment of labor market 

conditions can be obtained by combining the 

signals from many such indicators. Aside from 

the decline in the unemployment rate, probably 

the most important other pieces of evidence 

corroborating the gradnal improvement in 

labor market conditions over the second half 

of last year were the gains in nonfarm payrolls 

noted earlier and the slight net reduction in 

initial claims for unemployment insnranee. 

Restrained by the ongoing weak conditions 

in the labor market, labor compensation 

has increased slowly. The employment cost 

index for private industry workers, which 

encompasses both wages and the cost to 

employers of providing benefits, increased 

only 2 percent over the 12 months of 2012, 

similar to the rate of gain since 2010 (figure 5). 

Similarly, nominal compensation per honr 

in the nonfarm business sector-a measure 

derived from the labor compensation data in 

the national income and prod net accounts 

(NIPA)-increased 2V, percent over the four 

quarters of 2012, well below average increases 

2. See, for example, Mary C. Daly, Bart Hobijn, 

Ay,egiiI $ahin, and Robert G. Valletta (2012), "A 

Search and Matching Approach to Labor Markets: 

Did the Natural Rate of Unemployment Rise?" Journal 

of Economic Perspectives, vol. 26 (Summer), pp. 3-26; 

Michael W. L. Elsby, Bart Hobijn, Ay,egul $ahin, and 

Robert G. Valletta (20 II), "The Labor Market in the 

Great Recession-An Update to September 2011,'" 

Brookings Papers on Economic Activity, Fall, pp. 353--71~ 

and Jesse Rothstein (2012), "The Labor Market Four 

Years into the Crisis: Assessing Structural Explanations," 

ILRRevielV, vol. 65 (July), pp. 467-500. 

MONETARY POliCY REPORT: FEBRUARY 2013 7 

5. Measures of change in hourly compensation, 

2002-12 

2012 

Percent 

NOTE: The data are quarterly and extcnd through 2012.Q4. For nonfarm 

busine~s compensation, change is over four qmlflers; for the employment cost 

mdex (Eel), change is over the 12 months endmg in the last month of each 

quarter. The nonfann business sector excludes fanns, government, nonprofit 

institutions, and households. The sector covered by the EO used here IS the 

nonfaml busmcss scctor plus nonprofit institutions. 

SOGRCC Department of Labor, Bureau of Labor Statistics. 
79 


80869.022
80 


80869.023

() 
81 


80869.024

10 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

6. Change in the chain-type price index for personal 

consumption expenditures, 2006-12 

Perce;'!! 

II L II 

2006 2007 2008 2009 2010 2011 2012 

NOl 10: The data arc monthly and extend through December 2012; changes 

are from one year earlier. 

SOURO.: Department ofConuncrcc, Bureau of Economic Analysis 

7. Change in output per hour, 1948-2012 

Per~cnj, annual ratc 

NoT!': Nonfarm 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 immediulcJy preceding the period. 

SOURCr: Department of Labor, Bureau of Labor Statistics. 

of close to 4 percent in the years prior to the 

recent recession. As a result of these modest 

gains, nominal compensation has increased 

only about as fast as consumer prices over the 

recovery. 

Inflation remained low ... 

Consumer price inflation was low over the 

second half of 2012. With considerable slack 

in labor markets and limited increases in labor 

costs, relatively stable prices for commodities 

and imports, and well-anchored longer-term 

inflation expectations, prices for personal 

consumption expenditures (PCE) increased 

at an annual rate of I \I, percent in the second 

half of the year, similar to the rate of increase 

in the first half (figure 6). Excluding food and 

energy prices, consumer prices increased only 

1 percent in the second half of the year, down 

from 2 percent in the first half. A deceleration 

in prices of imported goods likely contributed 

to the low rate of inflation seen in the second 

half, though price increases for non-energy 

services were also low. 

As noted, gains in labor compensation have 

been subdued given the weak conditions in 

labor markets, and unit labor costs-which 

measure the extent to which compensation 

rises in excess of productivity-have increased 

very little over the recovery. That said, 

compensation per hour rose more rapidly 

last year, and productivity growth, which 

has averaged I '/, percent per year over the 

recovery, was relatively low (figure 7). As a 

result, unit labor costs rose 2 percent in 2012, 

well above average increases earlier in the 

recovery. 

Global oil prices rose in early 2012 but 

subsequently gave up those gains and remained 

about flat through the later part of the year 

(figure 8). Developments related to Iran, 

including a tightening embargo on Iranian oil 

exports, likely put upward pressure on prices, 

but these pressures were apparently offset 

by continued concerns about weak global 

demand. However, in recent weeks, global oil 
82 


80869.025

prices have increased in response to generally 

positive demand indicators from China and 

some reductions in Saudi production. Partly 

in response to this rise, retail gasoline prices, 

which changed little, on net, over 2012, have 

moved up appreciably. 

Nonfuel commodity prices have remained 

relatively flat over the past year despite 

significant movements in the prices of a few 

specific commodities. Of particular interest, 

prices for corn and soybeans eased some over 

the fall after having risen sharply during the 

summer as the scale of the drought affecting 

much of the United States became apparent. 

Given this easing and the small share of grain 

costs in the retail price of food, the effect of 

the drought on U.S. consumer food prices is 

likely to be modest: Consumer food prices 

rose at an annual rate of 2 percent in the 

fourth quarter following increases of less than 

I percent in the middle of last year. 

In line with these flat overall commodity 

prices, as well as earlier dollar appreciation, 

prices for imported goods excluding oil were 

about unchanged on average over the last five 

months of 2012 and the early part of 2013 . 

. . . and longer-term inflation 

expectations stayed in their historical 

range 

Survey measures of longer-term inflation 

expectations have changed little, on net, since 

last summer. Median expected inflation over 

the next 5 to 10 years, as reported in the 

Thomson Reuters/University of Michigan 

Surveys of Consumers, was 3 percent in 

early February, within the narrow range of 

the past 10 years (figure 9). In the Survey of 

Professional Forecasters, conducted by the 

Federal Reserve Bank of Philadelphia, the 

median expectation for the increase in the 

price index for PCE over the next 10 years 

was 2 percent in the first quarter of this 

year, similar to its level in recent years. A 

measure of 5-year inflation compensation 

derived from nominal and inflation-protected 

MONETARY POLICY REPORT: FEBRUARY 2013 11 

8. Prices of oil and nonfucl commodities, 2008-13 

DeC<,'lTlbcr20(l6"'"100 Ooli3rsperbarrci 

160 140 

120 

140 

100 

120 

80 

100 60 

80 40 

I I L __ ---L.l 2008 2009 2010 2011 2012 2013 

NOTE: The data are monthly. The 011 price is the spot pnce of Brent crude 

011, and the last observation is the average for fehruary 1-21, ~013. The price 

of lIonfuel commodities IS an mdex of 45 primary .. mmmodity prices and 

extends Ihrougll January 2013 

SOVR(T: For oil, the Commodity Research Bureau; for nonfucl 

commodities, lntemational Monetary Fund. 

9. Median inflation expectations, 2001-13 

!vlldllgan c;urv,;y C'.>.r('ct;!l!~lll~ 

f\): H¢'{t 5 \0 iO 

~ for next 10 yean, 

200 1 2003 1005 2007 2009 

NOTE: The Michigan survey data are monthly 

200 I through a preliminary estimate for February 

quarterly and extend from 2007:Ql through 2013:QJ, 

-~ 6 

SOURCE: Thomson Reuters/University of Michigan Surveys of Consumers 

and Survey of Professional Forecasters (SPF), 
83 


80869.026

12 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

10. Inflation compensation, 2004-13 

Percent 

------

-4 

Non.: The data are weekly averages of daily data and extend through 

Fehruary 15, 2013. lnflation compensation is the dlfferellce between yields 

on nominal Treasury securities and Treasury inOation-protected securities 

(TIPS) of comparable maturitIes, based on yield curves fitted to off-thc-run 

nomina! Treasury sccurillcs and on- and off-tnc-run TIPS. The 5-year 

measure is adjusted for the eflect of indexation lags. 

SOURCE: Federal Reserve Bank of New York; Barclay;;; Federal Reserve 

Board staff estimates. 

11. Change in real personal consumption expenditures and 

disposable personal income, 2006-12 

• Change in real peE 

o Change in real DPI 

Pco;;ent,3ntlualratc 

Treasury securities has increased 55 basis 

points since the end of June, while a similar 

measure of inflation compensation for the 

period 5 to 10 years ahead has increased about 

30 basis points; both measures are within their 

respective ranges observed in the several years 

before the recent financial crisis (figure 10). 

While the increases in these measures could 

reflect changes in market participants' 

expectations of future inflation, they may 

also have been affected by improved investor 

risk sentiment and an associated reduction in 

demand for the relatively greater liquidity of 

nominal Treasury securities. 

Consumer spending continued to 

increase moderately 

Turning to some important components 

of final demand, real peE increased at a 

moderate annual rate of 2 percent over the 

second half of 2012, similar to the rate of 

increase in the first half (figure 11). Household 

wealth-buoyed by increases in house prices 

and equity values·-moved up over the second 

half of the year and provided some support 

for consumer spending (figure 12). In addition, 

for those households with access to credit, 

low interest rates spurred spending on motor 

vehicles and other consumer durables, which 

increased at an annual rate of 11 percent over 

the second half of last year. But increases in 

real wages and salaries were modest over the 

second half of the year, and overall growth in 

consumer spending continued to be held back 

by concerns about the economic outlook and 

limited access to credit for some households. 

After rising earlier in the year, consnmer 

sentiment·-which reflects household views 

on their own financial sitnations as well as 

broader economic conditions-fell back at the 

end of the year and stood well below longerrun norms (figure 13). 

Real disposable personal income (DPI) rose at 

an annual rate of 3J

h percent over the second 

half of 2012. However, much of this increase 

was a result of unusually large increases in 

dividends and employee bonuses, as many 

firms apparently shifted income disbursements 
84 


80869.027

into 2012 in anticipation of an increase in 

marginal tax rates for high-income households 

at the beginning of this year. Excluding these 

special payments, real DPI is estimated to 

have increased at a modest annual rate of 

1 \!4 percent over the second half of the year, 

similar to the average pace of increase over 

the recovery. The surge in dividend and bonus 

payments also led the personal saving rate to 

jump from 3.8 percent in the second quarter 

to 4.7 percent in the fourth quarter (figure 14). 

In their absence, the saving rate would have 

likely been little changed over the second half 

of the year. 

Households continue to pay down debt 

and gain access to credit 

Household debt---the sum of mortgage 

and consumer debt---edged down further 

in the third quarter of 2012 as a continued 

contraction in mortgage debt more than offset 

a solid expansion in consumer credit. With 

the reduction in household debt, low levels 

of most interest rates, and modest income 

growth, the household debt service ratiothe ratio of required principal and interest 

payments on outstanding household debt to 

DPI-decreased further and, at the end of the 

third quarter, stood at a level last seen in 1983 

(figure 15). 

Consumer credit expanded at an annual 

rate of about 5\!4 percent in the second half 

of 2012. Nonrevolving credit (mostly auto 

loans and student loans), which accounts for 

about two-thirds of total consumer credit 

outstanding, drove the increase. Revolving 

consumer credit (primarily credit card 

lending) was about flat on net. Overall, the 

increase in nonrevolving consumer credit is 

consistent with banks' recent responses to the 

Senior Loan Officer Opinion Survey on Bank 

Lending Practices (SLOOS), which indicated 

that demand had strengthened and standards 

eased, on net, for aulo loans (figure 16)3 

3. The SLOOS is available on the Federal Reserve 

Board's website at www.fcderalreservc.gov/boarddocs/ 

SnLoanSurvcy. 

MONETARY POLICY REPORT: FEBRUARY 2013 13 

12. Wealth-to-incomc ratio, 1989-2012 

_______ ...:..Rauo 

-4 

NorE: The data are quarterly and extend through 2012:Q3. The series is 

the raho of household net worth to disposable persona! income 

SouRn.: For nct worth, Federal Rcscrve Board, flow of funds data; for 

income, Department ofComm<.'fce, Bureau of Economic Analysis. 

13. Consumer sentiment indexes, 1999-2013 

14" 

120 

100 

80 

40 

20 

200l 2004 

NOTE: The Conference Board data, indexed to 100 in 1985, arc monthly 

and extend through Jan. 2013. The Mich. survey data, indexed to 100 in 

1966, are monthly and extend through a preliminary Feb 2013 estimate. 

SOURCE: The Conference Board and Thomson RcutcrsiUnivcrsity of 

Michigan Surveys of Consumers 

14. Personal saving rate, 1989-2012 

_________________ Pcrccnt 

-3 
85 


80869.028

14 PART 1; RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

15. Household debt service, 1980-20 l2 

___ l'_C!L_,"_t of<l!sposal::lJe Hlcomc 

LLLuLLL I lJJ,J_LLLLLLLU~LLLlJ.ll.LJ 

1980 1984 1988 1992 1996 2000 2004 2008 2012 

14 

13 

12 

11 

NOTE: The data arc quarterly and extend through 2012:Q3. Debt service 

payments consist of estimated required payments on olltstanding mortgage 

and consumer debt 

SOURCE: Federal Reserve Board. "Household Debt Service and Financial 

Obligations Ratios," statistical release. 

16. Change in standards and demand for auto loans, 

2011-12 

NClperccIlt 

Demand 

------"~~~-

~ Q2 Q3 Q4 i·"CQ"'t,-L-;Q"'2-L-;'Q~3 ...lL'Q4-LJ 

2011 2012 

40 

30 

20 

10 

10 

20 

30 

NOlL: The data arc from a survey generally conducted 4 tim,"s per year: 

the last observation is from the Jan. 1013 survey, which covers 2012:Q4. 

Each senes the net percent of surveyed banks that reported a 

of or stronger demand for auto loans over the past 

Federal RCllerve Board, Senior Loan Officer Opinion Survey on 

Bank Lending Practices. 

Changes in interest rates on consumer loans 

were mixed over the second half of 2012. 

Interest rates on auto loans declined a bit, as 

did most measures of the spreads of rates on 

these loans over yields on Treasury securities 

of comparable maturity. Interest rates on 

credit card debt quoted by banks generally 

declined slightly, while rates observed in credit 

card offer mailings continued to increase, 

The housing market recovery gained 

traction ... 

The housing market has continued to recover. 

Housing starts, sales of new and existing 

hQmes, and builder and realtor sentiment all 

increased Qver the second half of last year, 

and residential investment rose at an annual 

rate of nearly 15 percent. Combined, singlefamily and multifamily housing starts rose 

from an average annual rate of 740,000 in the 

second quarter of last year to 900,000 in the 

fourth quarter (figure 17), Activity increased 

most noticeably in the smaller multifamily 

sector-where starts have nearly reached prerecession levels-as demand for new housing 

has apparently shifted toward smaller rental 

units and away from larger, typically owneroccupied single-family units. 

... as mortgage interest rates reached 

record lows and house prices rose ... 

Mortgage interest rates declined to 

historically low levels toward the end of 

20l2-importantly reflecting Federal Reserve 

policy actions-making housing quite 

affordable for households with good credit 

ratings (figure 18). However, the spread 

between mortgage rates and yields on agencyguaranteed mortgage-backed securities (MBS) 

remained elevated by historical standards. 

This unusually wide spread probably reflects 

still-elevated risk aversion and some capacity 

constraints among mortgage originators. 

Overall, refinance activity increased briskly 

over the second half of 20l2-though it was 

still less than might have been expected, given 

the level of interest rates-while the pace of 

mortgage applications for home purchases 
86 


80869.029

remained sluggish (figure 19). Recent responses 

to the SLOOS indicate that banks' lending 

standards for residential mortgage loans were 

little changed over the second half of 2012. 

House prices, as measured by several national 

indexes, continued to increase in the second 

half of 2012. For example, the CoreLogic 

repeat-sales index rose 312 percent (not an 

annual rate) over the last six months of 

the year to reach its highest level since late 

2008 (figure 20). This recent improvement 

notwithstanding, this measure of house prices 

remained 27 percent below its peak in early 

2006. 

... but the level of new construction 

remained low, and mortgage 

delinquencies remained elevated 

Despite the improvements seen over the second 

half of 2012, housing starts remained well 

below the 1960-2000 average of 1.5 million 

per year, as concerns about the job market 

and tight mortgage credit for less-creditworthy households continued to restrain 

demand for housing. In addition, although the 

number of vacant homes for sale has declined 

significantly, the stock of vacant homes held 

off the market remained quite elevated. Once 

put on the market, this "shadow" inventory, 

which likely includes many bank-owned 

properties, may redirect some demand away 

from new homes and toward attractively priced 

existing homes. With home values depressed 

and unemployment still high, measures of 

late-stage mortgage delinq uency, such as 

the inventory of properties in foreclosure, 

remained elevated, keeping high the risk of 

homes transitioning to vacant bank-owned 

properties (figure 21). 

Growth of business investment has 

slowed since earlier in the recovery 

After increasing at double-digit rates in 2010 

and 20 II, business expenditures on eqnipment 

and software (E&S) decelerated in 2012 

(figure 22). Pent-np demand for capital goods, 

an important contributor to earlier increases 

MONETARY POLICY REPORT; FEBRUARY 2013 15 

17. Private housing starts, 1999--2013 

MilhonsQfUll\!s,annualrale -------~ 

.Mllhif,Unlly 

1999 2001 2003 200S 2011 2013 

Non:: The data are monthly and extend through January 2013. 

SOURCE: Department of Commerce, Bureau of the Census, 

18. Mortgage interest rates, 1995~2013 

18 

14 

10 

-7 

LLl .. LLll I I I I I I I I I LLLLLJ 

1995 J 998 2001 2004 2007 20 I 0 20!3 

NO:t: The data, which are weekly and extend through February 20, 2013, 

are contract rates on 30-year mortgages 

SOURCE: Federal Home Loan Mortgage Corporation 

19. Mortgage Bankers Association purchase and refinance 

indexes, 1990··-2013 

March 16, 1990= 100 M;uchI6,199D--IOO 

500 10,000 

40() 8,000 

6,000 

200 4,000 

100 2,000 

Non: The dala, which are seasonally adjusted, are a four~week moving 

average and extend through February 15,1013. 

SOURCE: Mortgage Bankers Association 
87 


80869.030

Ih 
88 


80869.031

H111(1 I! 

I'll 
89 


80869.032

II~r\""{ 
90 


80869.033

high, as some borrowers with five-year loans 

issued in 2007 were unable to refinance upon 

the maturity of those loans because of high 

loan-to-value ratios. While delinquency 

rates for eRE loans at commercial banks 

continued to decline, they remained somewhat 

elevated, especially for construction and land 

development loans. 

Budget strains for state and local 

governments eased, but federal purchases 

continued to decline 

Strains on state and local government 

budgets appear to have lessened some since 

earlier in the recovery. Although federal 

grants provided to state governments in the 

American Recovery and Reinvestment Act 

have essentially phased out, state and local 

tax receipts, which have been increasing since 

2010, rose moderately further over the second 

half of last year. Accordingly, after declining 

at an annual rate of I Y, percent in the first 

half of last year, real government purchases 

at the state and local level changed little in the 

second half (figure 27). Similarly, employment 

levels at states and municipalities, which had 

been declining since 2009, changed little, on 

balance, over the second half of last year. 

Federal purchases continued to decline over 

the second half of 2012, reflecting ongoing 

efforts to reduce the budget deficit and the 

scaling back of overseas military activities. 

As measured in the NIPA, real federal 

expenditures on consumption and gross 

investment-the part of federal spending 

included in the calculation of GDP-fell at 

an annual rate of 3 Y, percent over the second 

half of 2012. Real defense spending fell at an 

annual rate of a little over 6 percent, while 

nondefense purchases increased at an annual 

rate of 2 percen t. 

The deficit in the federal unified budget 

remains high. The budget deficit for fiscal 

year 2012 was $1.1 trillion, or 7 percent of 

nominal GDP, down from the deficit recorded 

in 2011 but still sharply higher than the 

MONFTARY POLICY REPORT: FEBRUARY 2013 19 

27. Change in real government expenditures 

on consumption and investment, 2006-12 

____ f'ercenl,annaalrate 

o Federal 

• State and 

10001 ~ IL 

[I, [l. l L-ll-lJ LI HI Hl 

u_ .. __ l_--'_--'~ -1~--'-~--'-~--...LU. 

2006 2007 2008 2009 2010 2011 2012 

SOCRCf.: Department of Commerce, Bureau of Econonllc Analysis 
91 


80869.034

20 PART 1, RECENT ECONOMIC AND rlNANCIAL DEVELOPMENTS 

28, Federal receipts and expenditures, 1992-2012 

Percent (Jfrwmmal GDP 

24 

Receipts 22 

20 

18 

16 

14 

LLLl I ! I ! I I LLLL.L.LLLLLL-L_l.J-.J 1992 1996 2000 2004 2008 2012 

:;\IOTE: The receipts and expenditures dala afC on a unified-budget basis and 

are for fiscal years (October through Septembo:r); gross domestic product 

(GDP) is for the four quarters cnding in 03. 

SOVRCf:.: Offi~ of Management and Budget 

29. Federal government debt held by Ihe public, 1960-2012 

PcrcentofnomiualGDP 

70 

60 

50 

40 

30 

,- 20 

Ll!!!! 1111111 II Ill! III!!! 11111 II! I! III II! III! 1111LillJJ-J 

1962 1972 1982 1992 2002 2012 

NOTE: The data for debt through 2012 are as of year-end. and the 

corrcspondmg values for gross domestic product (GDP) are for Q4 at an 

annual rate. Excludes securities held as investments of federal government 

ac,ounls. 

SOURCE: Bureau of Economic Analysis; Department of the Treasury, 

Fmancial Management Service 

30. Change in real imports and exports of goods 

and services, 2007-12 

Pcn:ea!. amlU;ll tate 

o lmpnrts 

II Exports 

LL- I -L_-L-_l----Ll 2007 2008 2009 2010 2011 2012 

SOURCE: Department of Commerce, Bureau ofEcormmic Analysis 

15 

10 

deficits recorded prior to the onset of the last 

recession. The narrowing of the budget deficit 

relative to fiscal 20 I I reflected an increase in 

tax revenues that largely stemmed from the 

gradual increase in economic activity as well 

as a decline in spending. Despite the rise in 

tax revenues, the ratio of federal receipts to 

national income, at 16 percent in fiscal 2012, 

remained near the low end of the range for 

this ratio over the past 60 years (figure 28). 

The ratio of federal outlays to GDP declined 

but was still high by historical standards, at 

23 percent. With deficits still large, federal 

debt held by the public rose to 73 percent of 

nominal GDP in the fourth quarter of 2012, 

5 percentage points higher than at the end of 

2011 (figure 29). 

Net exports added modestly to real GDP 

growth 

Real imports of goods and services contracted 

at an annual rate of nearly 2 percent over the 

second half of 2012, held back by the sluggish 

pace of U.S. demand (figure 30). The decline 

in imports was fairly broad based across major 

trading partners and categories of trade. 

Real exports of goods and services also fell at 

an annual rate of about 2 percent in the second 

half despite continued expansion in demand 

from EMEs. Exports were dragged down by 

a steep falloff in demand from the euro area 

and declining export sales to Japan, consistent 

with weak economic conditions in those areas. 

In contrast, exports to Canada remained 

essentially flat. Across the major categories 

of exports, industrial supplies, automotive 

products, and agricultural goods contributed 

to the overall decrease. 

Overall, real net exports added an estimated 

0.1 percentage point to real GDP growth in 

the second half of 2012, according to the 

advance estimate of GDP from the Burean 

of Economic Analysis, but data received 

since then suggest a somewhat larger positive 

contribution. 
92 


80869.035
93 


80869.036

22 PART 1, RECENT ECONOMIC AND FINANCiAL DEVElOPMEN IS 

33. Net saving, 1992-2012 

Percent of nom mal GDP 

Nonfederal saving 

L_LLL.! I ! I ! I I I I I I I LLLLLu...J 1992 ! 996 2000 2004 2008 20 J 2 

NOTE: The data are quarterly and extend through 2012:Q3. Nonfederal 

saving is the sllm of personal and net business saving and the net ~avmg of 

state and local governments. GDP is gross domestic produce 

SOURCl-: Department of Commerce, Bureau of Economic Analysis. 

34. lnterest rates on Treasury securities at selected 

maturities, 2004-13 

-----.------

\ I 'f,.'v-, __ . 

---'--- ¥V.;;----; 

1"'\"1 I 

LL-L "LI _~=_'_-~I=J I I ~1 ! I 

2005 2007 2009 20 II 20 J3 

NOTE: The data are daily and extend through febnmry 2i, 2013 

inflation-protected securities (TIPS) are bast-d on yield curves 

federal Reserve staff to 00- and off-the-run T1PS. 

Department of the TreaslUY; Barclays; Federal Reserve Board 

Financial Developments 

Expectations regarding the future 

stance of monetary policy reflected the 

additional accommodation provided by 

the Federal Open Market Committee ... 

In response to the steps taken by the FOMe 

to provide additional monetary policy 

accommodation over the second half of 

2012, market participants pushed out the 

date when they expect the federal funds rate 

to first rise above its current target range of 

o to Y. percent In particular, interest rates on 

overnight index swaps indicate that investors 

currently anticipate that the effective federal 

funds rate will rise above its current target 

range around the fourth quarter of 2014, 

roughly four quarters later than they expected 

at the end of June 2012. Meanwhile, the modal 

target rate path--·-the most likely values for 

future federal funds rates derived from interest 

rate options-suggests that investors think 

the rate is most likely to remain in its current 

range through the first quarter of 2016. In 

addition, recent readings from the Survey 

of Primary Dealers conducted by the Open 

Market Desk at the Federal Reserve Bank of 

New York suggest that market participants 

expect the Federal Reserve to hold about 

$3.75 trillion of Treasury and agency securities 

at the end of 2014, roughly $1 trillion more 

than was expected in the middle of 2012.' 

... and held yields on longer-term 

Treasury securities and agency mortgagebacked securities near historic lows 

Yields on nominal and inflation-protected 

Treasury securities remained near historic 

lows over the second half of 2012 and 

into 2013. Yields on longer-term nominal 

Treasury securities rose, on balance, over this 

period, while yields on inflation-protected 

securities fell (figure 34). These changes likely 

5. The Survey of Primary Dealers is available on 

the Federal Reserve Bank of New York's website at 

www.newyorkfed.org/markets/primarydealecsurvey_ 

questions.htmL 
94 


80869.037

reflect the effects of additional monetary 

accommodation, a substantial improvement 

in sentiment regarding the crisis in Europe 

that reduced demand for the relative safety 

and liq uidity of nominal Treasury securities, 

and increases in the prices of key commodities 

since the end of June 2012. On balance, 

yields on 5-, 10-, and 30-year nominal 

Treasury securities increased roughly 15 basis 

points, 30 basis points, and 40 basis points, 

respectively, from their levels at the end of 

June 2012, while yields on 5- and 10-year 

inflation-protected securities decreased 

roughly 55 basis points and 15 basis points, 

respectively. Treasury auctions generally 

continued to be well received by investors, and 

the Desk's outright purchases and sales of 

Treasury securities did not appear to have a 

material adverse effect on liquidity or market 

functioning. 

Yields on agency MBS were little changed, 

on net, over the second half of 2012 and 

into 2013. They fell sharply following the 

FOMe's announcement of additional agency 

MBS purchases in September but retraced 

over subsequent months. Spreads of yields 

on agency MBS over yields on nominal 

Treasury securities narrowed, largely reflecting 

the effects of the additional monetary 

accommodation (figure 35). The Desk's 

outright purchases of agency MBS did not 

appear to have a material adverse effect on 

liquidity or market functioning, although 

implied financing rates for some securities in 

the MBS dollar roll market declined in the 

second half of 2012, and the Desk responded 

by postponing settlement of some purchases 

using dollar roll transactions6 

6. Dollar roll transactions consist of a purchase or sale 

of agency MBS with the simultaneous agreement to sell 

or purchase substantially similar securities on a specified 

fulure date. The Committee directs the Desk to engage in 

these transactions as necessary to facilitate settlement of 

the Federal Reserve's agency MBS purchases. 

MONETARY POLICY REPORT: FEBRUARY 2013 23 

35. Current-coupon yield and spread for agencyguaranteed mortgage-backed securities, 2009-13 

Percen1~ _____ _ _ ____ B::M::ispOll1lS 

175 

150 

125 

100 

I ! ! ! ! j ! ! ! I! ! ! ! ! ,I ! ! 

Jan, July Jan. July Jan. July Jan. July Jan. 

2009 2010 2011 2012 2013 

The data are daily and extend through febma.I)' 21, 2013. Yield 

shown for the Fannie Mae 30.year cument coupon, the coupon rale at 

""hleh new mortgage-backed s(X;uritles would be priced at par, or face, value. 

Spread shown is to the average of the 5- and lO.year nominal Treasury yields 

Sm;R("£: Department of the Treasury; Barclays 
95 


80869.038

24 PART 1: RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

36. Spreads of corporate bond yields over comparable 

off-the-run Treasury yields, by securities rating, 

1997-2013 

Percentagepomls -------------

SOURCE: Derived from smoothed corporate YIeld curves using Merrill 

Lynch bond data. 

37. S&P 500 index, 1995-2013 

_____ ..•• ______ . ___ .. _ Jan!lary2.201}9~ 100 

180 

~II-:~ V 80 

60 

40 

Yields on corporate bonds reached record 

lows, and equity prices increased 

Yields on investment- and speculative-grade 

bonds reached record lows in the second 

half of 2012 and early 2013, respectively, 

partly reflecting the effects of the FOMC's 

additional monetary policy accommodation 

and increased investor appetite for bearing 

risk. Spreads to comparable-maturity Treasury 

securities also narrowed substantially but 

remained above the narrowest levels that they 

reached prior to the financial crisis (figure 36). 

Prices in the secondary market for syndicated 

leveraged loans have increased, on balance, 

since the middle of 2012. 

Broad equity price indexes have increased 

about 10 percent since the end of June 2012, 

boosted by the same factors that contributed 

to the narrowing in bond spreads (figure 37). 

Nevertheless, the spread between the 12-month 

forward earnings-price ratio for the S&P 500 

and a long-run real Treasury yield-a rough 

gauge of the equity risk premium-remained 

at the high end of its historical range 

(figure 38). Implied volatility for the S&P 500 

index, as calculated from option prices, spiked 

at times but is currently near the bottom end 

of the range it has occupied since the onset of 

the financial crisis (figure 39). 

Conditions in short-term dollar funding 

markets improved some in the third 

quarter and remained stable thereafter 

Measures of stress in unsecured dollar funding 

markets eased somewhat in the third quarter 

of 2012 and remained stable at relatively low 

levels thereafter, reflecting improved sentiment 

regarding the crisis in Europe. For example, 

the average maturity of unsecured financial CP 

issued by institutions with European parents 

increased, on net, to around the same length 

as such CP issued by institutions with U.S. 

parents. 

Signs of stress were largely absent in secured 

short-term dollar funding markets. In the 

market for repurchase agreements (repos), 
96 


80869.039

bid-asked spreads and haircuts for most 

collateral types have changed little since the 

middle of 2012. However, repo rates continued 

to edge up over the second half of 2012, likely 

reflecting in part the financing of the increase 

in dealers' inventories of shorter-term Treasury 

securities that resulted from the maturity 

extension program (MEP). Following yearend, repo rates fell back as the MEP came 

to an end and the level of reserve balances 

began to increase. In asset-backed commercial 

paper (ABCP) markets, volumes outstanding 

declined a bit for programs with European and 

U.S. sponsors, while spreads on ABCP with 

European bank sponsors remained slightly 

above those on ABCP with U.S. bank sponsors. 

Year-end pressures in short-term funding 

markets were generally modest and roughly 

in line with the experiences during other years 

since the financial crisis. 

Market sentiment toward the banking 

industry improved as the profitability of 

banks increased 

Market sentiment toward the banking 

industry improved in the second half of 2012, 

reportedly driven in large part by perceptions 

of reduced downside risks stemming from the 

European crisis. Equity prices for bank holding 

companies (BHCs) increased, outpacing 

the increases in broad equity price indexes, 

and BHC credit default swap (CDS) spreads 

declined (figure 40). 

The profitability of BHCs increased in the 

second half of 2012 but continued to run 

well below the levels that prevailed before 

the financial crisis (figure 41). Measures of 

asset quality generally improved further, as 

delinquency and charge-off rates decreased for 

almost all major loan categories, although the 

recent improvement in delinquency rates for 

consumer credit in part reflects a compositional 

shift of credit supply toward higher-creditquality borrowers. Loan loss provisions were 

flat at around the slightly elevated levels seen 

prior to the crisis, though they continued 

to be outpaced by charge-offs. Regulatory 

MONETARY POLICY REPORT: FEBRUARY 2013 25 

38. Real long-run Treasury yield and 12~month forward 

earnings-price ratio for the S&P 500, 1995-2013 

______________________ Pc:e~1l1 

10 

NOTE: The data are monthly and extend through January 2013 The 

expe<:ted rcal yield on IO-year Treasury is defined as the off-thc-mn IO-year 

Treasury yield less the Federal Reserve Bank of Philadelphia's lO-ycar 

expected inflanon 

SOURCE: Standard & Poor's; Thomson Reuters Financial; Federal Reserve 

Board; Federa! Re,~erve Bank ofPhilade!phia 

39_ Implied S&P 500 volatility. 1995-2013 

PCf(:Cnl, llilno"l rate 

I ' ! I ! 1.1 ! ! I t I I I 1_.1 I I I I I ! 

1995 1998 2001 2004 2007 2010 2013 

80 

70 

60 

50 

40 

30 

20 

10 

Non,' 11u; data aJ'"C weekly and extend through the week endmg 

February 15, 2013. The senes shown···-the VIX-is the implied 30-d3Y 

volatility of the S&P 500 stock price index as calculated from a weIghted 

average of option!> prices 

SOURCE: Chicago Board Options Exchange 
97 


80869.040

26 PART 1, RECENT ECONOMIC AND FINANCiAL DEVELOPMENTS 

40. Spreads on credit default swaps for selected 

U.S. banking organizations, 2007-13 

Baslspo]ll!S 

--'_---' __ -L. ___ I _LJ 2009 2010 2011 2012 2013 

400 

:;50 

300 

250 

200 

150 

100 

50 

1\on:: The data are daily and extend through February 2l, 2013. Median 

spread~ for six large bank holding companies and nine other banks 

SOI]RCf" MaTh, 

41. Profitability of bank holding companies, 1997-2012 

Percent, annuai nlle _____ Pcrccnt, annual rate 

RctHm 'lli a~~cl~ 

L5 20 

LO 

10 .5 

.5 10 

10 

20 1.5 

I I I I I I L.-.L! ! ! ! ! I !...LL...LJ 1997 :WOO 2003 2006 2009 2012 

NOTE' The data, which arc seasonally adjusted, arc quarterly and extend 

through 2012:Q4. 

SOUR.CE: Federal Reserve Board, FR Y -9C, Consolidated Financial 

Statements for Bank Holdmg Companies. 

capital ratios remained at high levels based 

on current standards, but the implementation 

of generally more stringent Basel III capital 

requirements will likely lead to some decline in 

reported regulatory capital ratios at the largest 

banks. Overall, banks remain well funded 

with deposits, and their reliance on short-term 

wholesale funding stayed near its low levels 

seen in recent quarters. The expiration of 

the Federal Deposit Insurance Corporation's 

Transaction Account Guarantee program 

on December 31, 2012, does not appear to 

have caused any significant change in the 

availability of deposit funding for banks. 

Credit provided by commercial banking 

organizations in the United States increased 

in the second half of 2012 at about the same 

moderate pace as in the first half of the year. 

Core loans-the sum of C&I loans, real 

estate loans, and consumer loans--expanded 

modestly, with strong growth in C&lloans 

offsetting weakness in real estate and credit 

card loans (figure 42). Banks' holdings of 

securities continued to rise moderately overall, 

as strong growth in holdings of Treasury and 

municipal securities more than offset modest 

declines in holdings of agency MBS. 

Despite continued improvements in 

market conditions, risks to the stability of 

financial markets remain 

While conditions in short-term dollar funding 

markets have improved, these markets remain 

vulnerable to potential stresses. Money market 

funds (MMFs) have sharply reduced their 

overall exposures to Europe since the middle 

of 2011, but prime fund exposures to Europe 

continue to be substantial. MMFs also remain 

susceptible to the risk of investor runs due 

to structural vulnerabilities posed by the 

rounding of net asset values and the absence 

of loss-absorbing capitaL' 

7. ]n November 2012, the Financial Stability Oversight 

Council proposed recommendations for structural 

reforms of U.S. MMFs to reduce their vulnerability to 

runs and mitigate associated risks to the financial system. 
98 


80869.041

Dealer firms have reduced their wholesale 

short-term funding ratios and have increased 

their liquidity buffers in recent years, but 

they still heavily rely on wholesale short-term 

funding, As a result, they remain susceptible 

to swings in market confidence and a possible 

resurgence of anxiety regarding counterparty 

credit risk. Respondents to the Senior Credit 

Officer Opinion Snrvey on Dealer Financing 

Terms indicated that credit terms applicable to 

important classes of counterparties were little 

changed over the second half of 20128 Dealers 

reported increased demand for funding of 

securitized products and indicated that the use 

of financial leverage among trading real estate 

investment trusts, or REITs, had increased 

somewhat. However, respondents continued 

to note an increase in the amount of resources 

and attention devoted to the management 

of concentrated exposures to central 

counterparties and other financial utilities as 

well as, to a smaller extent, dealers and other 

financial intermediaries. 

With prospective returns on safe assets 

remaining low, some financial market 

participants appeared willing to take on more 

duration and credit risk to boost returns. The 

pace of speculative-grade corporate bond 

issuance has been rapid in recent months, and 

while most of this issuance appears to have 

been earmarked for the refinancing of existing 

debt, there has also been an increase in debt 

to facilitate transactions involving significant 

risks. In particular, in bonds issued to finance 

private equity transactions, there has been a 

reemergence of payment-in-kind options that 

permit the issuer to increase the face value of 

debt in lieu of a cash interest payment, and 

anecdotal reports indicate that bond covenants 

arc becoming less restrictive. Similarly, 

issuance of bank loans to finance dividend 

recapitalization deals as well as covenant-lite 

loans was robnst over the second half of the 

8. The Senior Credit Officer Opinion Survey on Dealer 

Financing Terms is available on the Federal Reserve 

Board's website at www.federalrcserve.gov/econresdata/ 

releases/secos.htm. 

MONETARY POLICY REPORT: FEBRUARY 2013 27 

42. Change in commercial and industrial loans and core 

loans, J 990-20 I 2 

I'cr<:CIlI,allnuairatc 

30 

20 

10 

10 

20 

30 

LLLLLLI I j ! I I ! I ! I Ll_! I j i I I I I 

199! 1994 1997 2000 2003 2006 2009 2012 

NOTE: The data, which are seasonally adjusted, arc quarterly and extend 

through 2012:Q4. Core loans consist of commercia! and industrial loans, real 

estate loans. and consumer loans. Data have been adjusted for banks' 

implementation of Gertain accounting rule changes (bleluding the Financial 

Accounting Standards Board's Statements of Financial Accounting Standards 

Nos. 166 and 167) and for the cffects of large nonbank institutions converting 

to commercial banks or mcrging with a commercial bank 

SOUf!,CE; Federal Reserve Board, Statistical Release H.8, "Assets and 

Liabtlities of Commercia! Banks in the United States."' 
99 


80869.042

28 PART 10 RECENT ECONOMIC AND FINANCIAL DEVELOPMENTS 

Table 1. Selected components of the Federal Reserve balance sheet, 2012--13 

Millions of dollars 

Balance sheet item 

Total assets ... 

Pnmarycredit... 

Central hank liquidity swaps. 

Feb,22, 

2012 Feb. 20. 

2013 

2,935.149 2,865,698 3,0%,802 

18 

107,959 27,059 5.192 

4,773 439 

845 507 

Lane LLC, Maiden Lane II LLC. and Maiden Lane III LLCI ,. 30.822 15,031 1,4151 

TotlllliabHities, ..... 

Sek'Cted liabilities 

year. (leor a discussion of regulatory steps 

taken related to financial stability, see the 

box "The Federal Reserve's Actions to Foster 

Financial Stability.") 

Federal Reserve assets increased, and the 

average maturity of its Treasury holdings 

lengthened ... 

Total assets of the Federal Reserve increased 

to S3,097 billion as of February 20,2013, 

$231 billion more than at the end of 

June 2012 (table J). The increase primarily 

relleets growth in Federal Reserve holdings 

of Treasury secnrities and agency MBS as a 

result of the purchase programs initiated at the 

September 2012 and December 2012 FOMC 

meetings. As of February 20,2013, the par 

1,656,581 1,666,530 

100,817 91,484 

853.045 854,979 1,032,712 

2,880,556 2,811,629 3,04J.820 

1.048,004 

89.824 

1,622,800 

0 

36,033 1I7,923 40,703 

0 0 0 

54.594 54,669 54,982 

valne of Treasury securities and agency MBS 

held by the Federal Reserve had increased 

$70 billion and $178 billion, respectively, 

since the end of June 2012. The composition 

of Treasury securities holdings also changed 

over the second half of 2012 as a result 

of the continuation of the MEP, which was 

announced at the June 2012 FOMC meeting. 

Under this program, between July and 

December, the Desk purchased $267 billion in 

Treasury securities with remaining maturities 

of 6 to 30 years and sold or redeemed an 

equal par value of Treasury securities with 

maturities of 3 years or less. As a result. the 

average maturity of the Federal Reserve's 

Treasury holdings increased 1.7 years over the 

second half of 2012 and into 2013 and, as of 

February 2013, stood at 10.5 years. 
100 


80869.043

· .. while exposure to facilities 

established during the crisis continued to 

wind down 

In the second half of 2012, the Federal 

Reserve continued to reduce its exposure to 

facilities established during the financial crisis 

to support specific institutions, The portfolio 

holdings of Maiden Lane LLC and Maiden 

Lane III LLC--entities that were created 

during the crisis to acquire certain assets 

from The Bear Stearns Companies, Inc., and 

American International Group, Inc" to avoid 

the disorderly failures of those institutions--

declined $14 billion to approximately 

$1 billion, primarily reflectiug the sale of the 

remaining securities in Maiden Lane III LLC 

that was announced in August 2012, These 

sales resulted in a net gain of $6,6 billion for 

the benefit of the U.S, public, The Federal 

Reserve's loans to Maiden Lane LLC 

and Maiden Lane III LLC had been fully 

repaid, with interest, as of June 2012, Loans 

outstanding under the Term Asset-Backed 

Securities Loan Facility (TALF) decreased 

$4 billion to under $1 billion because of 

prepayments and maturities of TALF loans, 

With accumulated fees collected through 

TALF exceeding the amount of TALF 

loans outstanding, the Federal Reserve and 

the Treasury agreed in January to end the 

backstop for TALF provided by the Troubled 

Asset Relief Program, 

The improvement in offshore U.S, dollar 

funding markets over the second half of 2012 

led to a decline in the outstanding amount 

of dollars provided through the temporary 

U.S, dollar liquidity swap arrangements 

with other central banks, As of February 20, 

2013, draws on the liquidity swap lines were 

$5 billion, down from $27 billion at the end of 

June 2012, On December 13, 2012, the Federal 

Reserve announced the extension of these 

arrangements through February 1,2014, 

On the liability side of the Federal Reserve's 

balance sheet, deposits held by depository 

institutions increased $176 billion since 

MONETARY POLICY REPORT; FEBRUARY 2013 29 

June 2012, while Federal Reserve notes in 

circulation rose $60 billion, reflecting solid 

demand both at home and abroad, M2 

has increased at an annual rate of about 

8 percent since June 2012, Holdings of M2 

assets, including 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 due to investors' continued 

preference to hold safe and liquid assets, 

As part of its ongoing program to ensure the 

readiness of tools to manage reserves, the 

federal Reserve conducted a series of smallvalue reverse repurchase transactions using 

all eligible collateral types with its expanded 

list of counterparties, as well as a few smallvalue repurchase agreements with primary 

dealers, In the same vein, the Federal Reserve 

continued to offer small-value term deposits 

through the Term Deposit Facility to provide 

eligible institutions with an opportunity 

to become familiar with term deposit 

operations, 

International Developments 

Foreign financial market stresses 

abated ... 

Since mid-July, global financial market 

conditions have improved, on balance, in 

part reflecting reduced fears of a significant 

worsening of the European fiscal and financial 

crisis, Market sentiment was bolstered 

by a new European Central Bank (ECB) 

framework for purchases of sovereign debt 

known as Outright Monetary Transactions 

(OMT), agreements on continued officialsector support for Greece, progress by Spain 

in recapitalizing its troubled banks, and some 

steps toward fiscal and financial integration 

in Europe, Nevertheless, financial market 

stresses in Europe remained elevated, and 

policymakers still face significant challenges 

(see the box "An Update on the European 

Fiscal and Banking Crisis"), 
101 


80869.044

30 PART 1: RECENT ECONOMIC AND fiNANCIAL DEVELOPMENTS 

The Federal Reserve's Actions to Foster Financial Stability 

The Federal Reserve continued to take actions 

in the second half of 2012 and early 2013 to meet 

its financial stability responsibilities. Although 

much remains to be done, the Federal Reserve 

has implemented regulatory reforms to strengthen 

the U.s. financial system, and it has taken further 

steps to gather information from the supervision of 

large banks, market reports, and other economic 

and financial sources to assess threats to financial 

stability. The Federal Reserve also has continued 

to work closely with its domestic regulatory 

counterparts and has taken actions to increase the 

resilience of the international financial regulatory 

architecture. 

Regulation 

A core element of the global regulatory 

community's efforts to improve banking regulation 

has been the development of the Basel III capital 

reforms. In June 2012, the Federal Reserve Board and 

the other u.s. banking agencies issued a proposal 

to amend the u.s. bank capital rules to implement 

these reforms. The Basel III reforms will raise the 

quantity of capital that must be held by u.s. banking 

firms, improve the quality of regulatory capital of 

those firms, and strengthen the risk-weight framework 

of u.S. bank capital rules. 

Consistent with the requirements of the DoddFrank Wall Street Reform and Consumer Protection 

Act of 201 0 (Dodd-Frank Act), the Board has 

also proposed rules to strengthen the oversight of 

the u.S. operations of foreign banks. Under the 

Board's December 2012 proposal. foreign banking 

organizations (FBOs) with a large u.s. presence 

would be required to create an intermediate holding 

company (tHe) Over their U.s. subsidiaries, which 

would help facilitate consistent and enhanced 

supervision and regulation of the U.S. operations of 

these foreign banks. An IHC of a foreign bank would 

be required to meet the same u.s. risk-based capital 

and leverage rules as a U.s. bank holding company 

(BHC). In addition, IHCs and the u.s. branches and 

agencies of foreign banks with a large U.S. presence 

would need to meet liquidity requirements similar to 

those imposed on U.S. BHCs. 

Progress in regulatory reform outside of the 

traditional banking sector has been notable as well. 

For example, as mandated by the Dodd-Frank Act, 

the new supervisory framework for systemically 

important financial market utilities (FMUs)-that 

is, those entities that provide the infrastructure 

to make payments and clear and settle financial 

transactions-has continued to take shape. In 

July 2012, the f-inancial Stability Oversight Council 

(FSOC) designated eight FMUs as systemically 

important and thus subject to enhanced riskmanagement standards. On July 30, the Federal 

Reserve Board approved a final rule establishing 

enhanced risk-management standards for designated 

FMUs supervised by the Federal Reserve. The rule 

also establishes processes to review and consult with 

the Securities and Exchange Commission (SEC) and 

the Commodity Futures Trading Commission (CFTC) 

on any proposed changes to the rules, procedures, 

or operations of certain designated FMUs that could 

materially affect the nature or level of their risk. 

The FSOC has also continued to make progress in 

its work to designate systemically important nonbank 

financial companies for consolidated supervision by 

the Federal Reserve. Relying primarily on data from 

publicly available reports, the FSOC is evaluating 

the potential systemic importance of a number of 

nonbank firms that meet the quantitative criteria 

for a first-stage review; to date, it has concluded 

that some finns warranted further consideration 

and has advanced them to the third and final stage 

of the determination process. Meanwhile, the 

International Association of Insurance Supervisors, 

under the oversight of the Financial Stability 

Board, has continued to move forward on crafting 

a methodology to identify global systemically 

important insurers and developing policy measures 

that would be applicable to those institutions. 

In addition, efforts to increase the resilience 

of "shadow banking," which refers to credit 

intermediation that occurs at least partly outside 

of the traditional banking system, are continuing. 

In November 2012, the FSOC proposed 

recommendations for structural reforms of U.S. 

money market funds to reduce their vulnerability to 

runs and mitigate associated risks to the financial 

system. Another set of reforms has been aimed 

at the triparty repurchase agreement markets, 

including efforts by the Federal Reserve to reduce 

the vulnerabilities created by the large amollnts of 
102 


80869.045

intraday credit provided by clearing banks in these 

markets. International regulatory groups have also 

been addressing the financial stability risks of 

shadow banking. 

Supervision 

The Federal Reserve has continued to work to 

embed its supervisory practices within a broader 

macroprudential framework. Annual stress tests, 

which assess the internal capital planning processes 

and capital adequacy of the largest BHes, continue 

to be an important element in its strengthened, 

cfOss-firm supervisory approach. The latest 

Comprehensive Capital Analysis and Review (CCAR 

2013), which covers the 18 largest BHCs (and is 

being conducted in a modified form for 11 other 

large SHCs), is now under way. In October 2012, 

the Board published final stress-testing rules under 

the Dodd-Frank Act, and it released the economic 

and financial market stress scenarios for CCAR 

2013 in November.' CCAR 2013 results will be 

released in March of this year. 

The Federal Reserve has also been working 

to improve the resolvability of the largest, most 

complex banking firms. The Dodd~-Frank Act 

created the Orderly Liquidation Authority (OLA) to 

improve the prospects for an orderly liquidation of 

a systemic financial firm and requires that all large 

BHes submit resolution plans to their supervisors. 

The Federal Deposit Insurance Corporation (FDIC) 

has been developing a single-point-of-entry strategy 

for resolving systemic financial firms under OlA, 

and the Federal Reserve, working closely with the 

FDIC, has been carefully reviewing the resolution 

plans (the so-called living wills) submitted in th(' 

summer and fall of 2012 by the largest and most 

complex 8HCs and FBOs. 

In Hne with a joint agency report to the Congress 

in July 2011, the Federal Reserve has continued 

1. Information on the Dodd-Frank Act stress tests 

and CCAR are available on the Federal Reserve Board's 

website at www.federalreseflle.gov/bankinfOfegistresstests-capital-p!anning.htm. 

MONETARY POLICY REPORT FEBRUARY 2013 31 

to work with the SEC and the CFTC to develop 

and implement effective superviSOry practices 

and techniques for deSignated FMUs, including 

appropriate information-sharing arrangements and 

Federal Reserve participation in SEC and erTC 

examinations of designated FMUs. 

Monitoring 

The Federal Reserve has continued to pursue 

an active program of research and data collection, 

often in conjunction with other U.s. and foreign 

regulators and supervisors, and to work on 

developing a framework and infrastructure for 

monitoring risks to financial stability. It continues 

to regularly monitor a variety of items that measure 

key financial vulnerabilities, such as leverage, 

maturity mismatch, interconnectedness, and 

complexity of financial institutions, markets, and 

products. In a context of adverse shocks, such 

vulnerabilities could lead to fire sales and an 

adverse feedback loop with credit availability, 

which could, in turn, inflict harm on the rea! 

economy. 

The Federa! Reserve pays special attention 

to developments at the largest, most complex 

financial firms, using both information gathered 

through supervision and indicators of financial 

conditions and systemic risk from financial markets. 

It has been analyzing the consequences for firms 

and markets resulting from the ongoing strains 

in European financial markets as we!! as those 

associated with the fiscal situation in the United 

States. Another issue that the Federal Reserve is 

monitoring closely is the potential incentive for 

some investors and institutions to take on excessive 

risk-for example, by increasing leverage, credit 

risk, and duration risk-in an attempt to reach for 

yield in a sustained low interest rate environment. 

Moreover, efforts are ongoing, both at the Federal 

Reserve and elsewhere, to evaluate and develop 

new macroprudential tools that could help limit 

buildups of systemic risk or increase the resilience 

of financial institutions and markets to potential 

adverse shocks. 
103 


80869.046

32 PART 1: RECENT ECONOMIC AND FINANCIAL DEVEl OPMENTS 

An Update on the European Fiscal and Banking Crisis 

In the second half of 2012, European 

policymakers stepped up efforts to support 

vulnerable euro-area economies, strengthen 

domestic public finances and banking systems, 

and reinforce the monetary union. As a result, 

Furopean financial stresses have moderated over 

the past several months. Nevertheless, they remain 

elevated, and European policymakers still face 

_ significant challenges as they seek to improve fiscal 

positions, implement growth-augmenting structural 

reforms, and bolster regional integration in a difficult 

economic environment. 

A key turning point in the euro-area crisis 

occurred in late July, when Mario Draghi, the 

European Central Bank (EeB) preSident, stated, 

"Within our mandate, the ECB is ready to do 

whatever it takes to preserve the eUrD."l The feB 

subsequently unveiled a framework for Outright 

Monetary Transactions (OMT) to address distortions 

in euro-area government bond markets that 

undermine the transmission of monetary policy. 

Under certain conditions, the ECB can purchase 

potentially unlimited amounts of government 

bonds.' To date, the ECB has not purchased any 

bonds under the GMT framework. Nevertheless, 

the announcement of the framework has mitigated 

investors' concerns about the adequacy of financial 

backstops for the Italian and Spanish governments 

and, more generally, about the integrity of the euro 

area, 

Vulnerable euro-area countries have made 

progress in strengthening their banking systems 

and public finances in recent months. The 

governments of Ireland and Portugal have been 

1. See Mario Draghi (2012), "Verbatim of the Remarks 

Made by Mario Draghi," speech delivered at the Global 

lnvestment ConferencE', london, July 26, www,ecb,intJ 

press/key/date/2012Ihtm!lsp 12072 6,en.html. 

2, The EeB's purchases will focus on government 

bonds with maturities of one to three years. The ECB will have full discretion over these purchases. A necessary 

condition for ECB purchases is that a government request a full or precautionary financial assistance program from 

the European Financial Stability Facility or the European 

Stability Mechanism. A government that already has 

such a program must regain market access, In addition, 

governments must fulfill their policy commitments under 

their programs and the euro-area governance framework 

generally fulfilling their policy commitmenls under 

their official financial assistance programs. In 

Spain, the government secured euro-area official 

approval and financing for its bank restructuring and 

recapitalization plans. In Greece, the government 

reinvigorated its long-stalled austerity and reform 

initiatives, In response, European authorities resumed 

fmancial assistance to the Greek government and 

took steps to address Greece's public debt burden, 

including easing the terms of euro-area official 

financing and funding a discounted buyback 

of roughly £30 billion in privately held Greek 

government debt. More generally, official financial 

assistance is continuing to provide vulnerable 

countries with breathing room to make the difficult 

adjustments needed to resolve their crises. 

European governments have also made some 

progress toward a European bJnking union. After 

protracted negotiations, European leaders agreed 

in December on key details of a Single supervisory 

mechanism (SSM) for European banks with the 

EeB at its center. The SSM is expected to be 

established sometime this spring and should enter 

into force in early 2014. The ECB will directly 

supervise large eura-area banks and will be able 

to assume (from national authorities) supervision 

of any euro-area bank when necessary to ensure 

consistent application of high supervisory standards. 

Establishment of the SSM is viewed as a necessary 

precondition for euro-area governments to share 

more directfy the fiscal burden of resotving 

national banking crises. In addition, European 

governments recently set objectives to accelerate 

the harmonization of national policy frameworks for 

bank resolution and deposit insurance and, further 

down the road, to create a single mechanism for 

bank resolution and recovery. 

In part because of the positive developments 

highlighted previously, financial stresses facing 

vulnerable European governments and banksthough still elevated-moderated substantially in the 

second half of 2012 and early 2013. Sovereign yields 

declined significantly even as the Italian and Spanish 

governments issued substantia! amounts of debt. 

In addition, the Irish and Portuguese governments 

began returning to bond markets; each conducted a 

limited, yet successful, sale of bonds in January. 
104 


80869.047

Reduced concerns about the European crisis 

contributed to an easing of funding conditions 

for European banks. Euro-area banks have 

relied somewhat less on ECB funding in 

recent months, and use of central bank dollar 

liquidity swap lines declined significantly. 

Reflecting market views of the decreased 

risk of defanlt, CDS premiums on the debt 

of many large banks in Europe dropped 

significantly, on net, especially for Italy and 

Spain, and euro-area bank stocks increased 

about 30 percent since mid-20 I 2 (figure 43). 

As risk sentiment improved, foreign equity 

indexes rose significantly: Over the second half 

of 2012 and into early 2013, equity indexes 

increased abont 10 percent for the United 

Kingdom and Canada, about 15 percent in 

the euro area, and about 25 percent in Japan; 

equity indexes in EMEs also moved up across 

the board, as shown in figure 43. Likewise, 

yields on 10-year government bonds in many 

countries increased moderately, though 

Japanese yields remained below 1 percent. 

Spreads of peripheral European sovereign 

yields over German bond yields of comparable 

maturity declined significantly as overall 

euro-area financial strains abated (figure 44). 

Corporate credit spreads also declined, and 

bond issuance picked up. 

The U.S. dollar depreciated nearly 1 percent 

against a broad set of currencies over the 

second half of 2012 and into early 2013 

(figure 45). Some of this depreciation reflected 

a reversal of flight-to-safety flows, in part 

stemming from the reduction in European 

financial stress. Indeed, the dollar depreciated 

4 percent against the euro. In contrast, the 

dollar appreciated 17 percent against the 

Japanese yen. Most of this rise came in recent 

months, as Shinzo Abe, the newly elected 

prime minister of Japan, called for the Bank 

of Japan to employ "unlimited easing" of 

monetary policy to overcome deflation. 

MONETARY POLICY REPORT, FEBRUARY 2013 33 

43. Equity indexes for selected foreign economies, 

2009-13 

June 30. 2009·~ 100 

t:.l'rl'-mC,l 

160 

150 

140 

130 

120 

llO 

100 

90 

80 

70 

60 

50 

L~ul~'-~~J->..L,~J 40 

2009 2010 20ll 2012 2013 

NOTE: The data arc daily. The last observatlOll for each series is 

February 20, 2013. Emerging markets are Brazil, Chile, China. Colombia, 

Czech Republic, Egypt, Hungary, India, Ind;)IlCsia, Malaysia, Mexico, 

Morocco, Peru, the Phitippmes, Poland. Russia, South Africa, South Korea, 

Taiwan, Thailand, and Turkey. 

SOURCE: For emerging markets, Morgan Stanky Emerging Markets MXEF 

Capital Index; for the curo area, Dow Jones Eum STOXX Index; for 

eUTo-area banks, Dow Jones Euro STOXX Bank Index; for Japan. Tokyo 

Stock Exchange (TOPIX); all via Bloomberg 

44, Government debt spreads for peripheral 

European economies, 2009-13 

U...w.J!!! I ),-1.1 .... ! !.! ! 1...1-! ! ! I __ J 2009 2010 2011 2012 2013 

Non.: The data arc weekly. The last observation for each 

February 15,2013, The spreads shown are the yields on 

the 1 O-year German bond yield 

32 

28 

24 

20 

16 

12 

SouRn: For Greece, Italy, P0I1ugal. and Spam, Bloomberg; for Ireland. 

staff estimates usmg traded bond prices from Thomson Reuters and 

Bloomberg. 
105 


80869.048

34 PART L RECENT ECONOMIC AND FINANCiAL DEVELOPMENTS 

45. U.S. dollar exchange rate against broad index 

and selected major currencies, 2010-13 

De<;cml>"r~I,21W<) 100 

LI ..J1c.w..Lw2clOI~0"""-'-'-'~~20~'~.L-cL~20.L'2~1 .L.Ll~ 

120 

ll5 

llO 

105 

100 

95 

90 

80 

NOTE: The data, which are in foreign currency unie; per dollar. arc daily. 

The Jast observation for each series is FebOiary 21, 2013. 

SOURCE: Fedeml Reserve Board. Statistical Release H.IO, "ForeIgn 

Exchange Rates," 

46. Real gross domestic product growth in selected 

advanced foreign economies, 2010-12 

?crcent,annualratc 

12 

12 

KOT(" The data are quarterly and extend through 20J2:Q3 for Canada and 

2012:Q4 for the curo area, Japan, and the United Kingdom. SOCRCE: For Canada, StatistIcs Canada: for the curo arca, Euwstat: for 

Japan. Cabinet Office of Japan; and for the United Kingdom, Office for 

National Statistics. 

... but economic activity in the advanced 

foreign economies continued to 

weaken ... 

Despite the easing of financial stresses in the 

euro area and some improvement in global 

financial markets, activity in the advanced 

foreign economies (AFEs) continued to lose 

steam in the second half of 2012 (figure 46). 

The euro area fell further into recession, as 

fiscal austerity, rising unemployment, and 

depressed confidence restrained spending, 

especially in the countries at the center of the 

crisis. Real GDP also contracted in Japan. 

reflecting plummeting exports. In the United 

Kingdom, real GDP growth resumed in the 

third quarter, partly thanks to a temporary 

boost to demand from the London Olympics, 

but contracted again in the fourth quarter. 

Canadian real GDP growth remained positive 

but also weakened, largely owing to lower 

external demand. Survey indicators suggest 

that conditions in the AFEs improved only 

marginally around the turn of the year. Amid 

this weakness in economic activity and limited 

pressures from commodity prices, inflation 

readings for most AFEs remained contained. 

Several foreign central banks expanded their 

balance sheets further and took other actions 

to support their economies (figure 47). Tn 

addition to its introduction of the OMT, the 

ECB lowered its main policy rate. The Bank 

of England completed its latest round of asset 

purchases, bringing its holdings to £375 billion, 

and began the implementation of its Funding 

for Lending Scheme, designed to boost lending 

to households and firms. The Bank of Japan 

took a number of steps. It introduced a new 

Stimulating Bank Lending Facility in October 

and raised its inflation target from 1 percent to 

2 percent in January. In addition, it increased 

the size of its Asset Purchase Program by 

¥30 trillion, to ¥I 0 I trillion, by the end of 2013 

and announced that purchases would be open 

ended beginning in 2014. 
106 


80869.049

· .. even as economic growth stabilized in 

emerging market economics 

After slowing earlier in the year, in part 

because of headwinds associated with Europe's 

troubles, economic growth in EMEs stabilized 

in the third quarter and appeared to pick up 

in the fourth. This modest pickup in economic 

activity in the face of continued weakness in 

exports to advanced economies was supported 

by monetary and fiscal policy stimulus. 

In China, following slower growth in the 

first half of 2012, stimulus measures helped 

boost the pace of real GOP growth in the 

second half of the year. Improved economic 

conditions in China also provided a lift 

to other emerging Asian economies. GOP 

accelerated in Hong Kong and Taiwan in the 

third quarter; in the fourth quarter, exports 

and purchasing managers indexes moved 

higher in most of the region, and GOP growth 

rebounded in a number of economies. 

After stagnating for about a year, economic 

activity in Brazil picked up in the third quarter 

to a still-lackluster pace of 2V, percent. 

Indicators for the fourth quarter suggest 

a further modest pickup, supported by 

accommodative policies. In contrast, GOP 

growth in Mexico continued to fall in the third 

quarter as the growth of U.S. manufacturing 

production slowed; however, Mexican 

growth picked up to 3 percent in the fourth 

quarter, boosted by services and the volatile 

agricultural sector. 

Despite occasional spikes in food prices, 

inflation in most emerging Asian economies 

remained well contained as moderate output 

growth limited broader price pressures. India 

was a notable exception, with 12-month 

inflation around 10 percent in recent months. 

In some Latin American economies, increases 

in food prices had a greater effect on inflation 

than in Asia, leading to 12-month price 

increases of around 5V, percent in Brazil and 

around 4'4 percent in Mexico over the second 

half of last year. 

MONETARY POLICY REPORT, FEBRUARY 2013 35 

47. Central bank assets in selected advanced 

economies, 2008-12 

Percenlofnol1li""IGUP 

35 

30 

25 

20 

15 

10 

1 t! ! ! I ! ! ! I ! f ! I ! I I I ! ! I ! 

2008 2009 2010 2011 2012 

NOTE: The data are quarterly and extc-nd through 2012:Q3 for the curo area 

and the United Kingdom and 20 12;Q4 for Japan_ 

SOURCE; For the curo area, European Central Bank and Eurostat; for Japan, 

Bank of Japan and Cabinet Office of Japan; and for the United Kingdom, 

Bank of England and Office for National Statistics. 
107 


80869.050
108 


80869.051

38 PART 2: MONETARY POLICY 

of Treasury securities that was announced 

in June 2012 and continued its policy of 

reinvesting principal payments from its holdings 

of agency debt and agency-guaranteed 

mortgage-backed securities (MBS) into agency 

MBS. 

At the September 12-13 meeting, the 

Committee agreed that the outlook called for 

additional monetary accommodation, and 

that such accommodation should be provided 

by both strengthening its forward guidance 

regarding the federal funds rate and initiating 

additional purchases of agency MBS at a 

pace of $40 billion per month. Along with the 

ongoing purchases of $45 billion per month 

of longer-term Treasury securities under the 

maturity extension program announced in June, 

these purchases increased the Committee's 

holdings of longer-term securities by about 

$85 billion each month through the end of the 

year. These actions were taken to put downward 

pressure on longer-term interest rates, support 

mortgage markets, and help make broader 

financial conditions more accommodative (see 

the box "EtIicacy and Costs of Large-Scale 

Asset Purchases"). The Committee agreed that 

it would closely monitor incoming information 

on economic and financial developments in 

coming months, and that if the outlook for the 

labor market did not improve substantially, it 

would continue its purchases of agency MBS, 

undertake additional asset purchases, and 

employ its other policy tools as appropriate 

until such improvement is achieved in a 

context of price stability. The Committee also 

agreed that in determining the size, pace, and 

composition of its asset purchases, it would, 

as always, take appropriate account of the 

likely etIicacy and costs of such purchases. 

This flexible approach was seen as allowing 

the Committee to tailor its policy over time 

in response to incoming information while 

clarifying its intention to improve labor market 

conditions, thereby enhancing the effectiveness 

of the action by helping to bolster business and 

consumer confidence. 

The Committee also modified its forward 

guidance regarding the federal funds rate at the 

September meeting, noting that exceptionally 

low levels for the federal funds rate were 

likely to be warranted at least through mid2015, longer than had been indicated in 

previous FOMC statements. Moreover, the 

Committee stated its expectation that a highly 

accommodative stance of monetary policy 

would remain appropriate for a considerable 

time after the economic recovery strengthens. 

The new language was meant to clarify that 

the Committee's anticipation that exceptionally 

low levels for the federal funds rate were likely 

to be warranted at least through mid-20lS did 

not reflect an expectation that the economy 

would remain weak, but rather reflected the 

Committee's determination to support a 

stronger economic recovery. 

At the December 11-12 meeting, members 

judged that continued provision of monetary 

accommodation was warranted in order 

to support further progress toward the 

Committee's goals of maximum employment 

and price stability. The Committee judged 

that, following the completion of the maturity 

extension program at the end of the year, 

such accommodation should be provided in 

part by continuing to purchase agency MBS 

at a pace of $40 billion per month and by 

purchasing longer-term Treasury securities at 

a pace initially set at $45 billion per month. 

The Committee also decided that, starting in 

January, it would resume rolling over maturing 

Treasury securities at auction. 

With regard to its forward rate guidance, the 

Committee decided to indicate in the statement 

that it expects the highly accommodative stance 

of monetary policy to remain appropriate for 

a considerable time after the asset purchase 

program ends and the economic recovery 

strengthens. In addition, it replaced the 

date-based guidance for the federal funds 

rate with numerical thresholds linked to the 

unemployment rate and projected inflation. 
109 


80869.052

MONETARY POLICY REPORT: fEBRLlARY 2013 39 

Efficacy and Costs of Large-Scale Asset Purchases 

In order to provide additional monetary stimulus 

when short-term interest rates are near zero, the 

Federal Reserve has undertaken a series of largescale asset purchase (LSAP) programs. Between late 

2008 and early 2010, the Federal Reserve purchased 

approximately $1.7 trillion in longer-term Treasury 

securities, agency debt, and agency mortgage-backed 

securities (MBS). From late 201 () to mid-20l1, a 

second round of LSAPs was implemented, consisting 

of purchases of $600 biltion in longer-term Treasury 

securities. Between September 2011 and the end of 

2012, the Federal Reserve implemented the maturity 

extension program and its continuation, under which 

it purchased approximately $700 billion in longerterm Treasury securities and sold or allowed to run off 

an equal amount of shorter-term Treasury securities. 

And in September and December 2012, the Federal 

Reserve announced flow-based purchases of agency 

MBS and longer~term Treasury securities at initial paces 

of $40 billion and $45 billion per month, respectively. 

These purchases were undertaken in order to put 

downward pressure on longer-term interest rates, 

support mortgage markets, and help to make broader 

financial conditions more accommodative, thereby 

supporting the economic recovery. One mechanism 

through which asset purchases can affect financial 

conditions is the "portfolio balance channel," which 

is based on the premise that different financial assets 

may be reasonably close but imperfect substitutes 

in investors' portfolios. This assumption implies that 

changes in the supplies of various assets available 

to private investors may affect the prices or yields 

of those assets and the prices of assets that may be 

reasonably close substitutes. As a result, the Federal 

Reserve's asset purchases can push up the prices 

and lower the yields on the securities purchased 

and influence other asset prices as well. As investors 

further rebalance their portfolios, overall financial 

conditions should ease more generally, stimulating 

economic activity through channels similar to those 

for conventional monetary policy. In addition, asset 

purchases could also signal that the central bank 

intends to pursue a more accommodative policy 

stance than previously thought, thereby lowering 

investor expectations about the future path of the 

federal funds rate and putting additional downward 

pressure on longer-term yields. 

A substantial body of empirical research finds that 

the Federal Reserve's asset purchase programs have 

significantly lowered longer-term Treasury yields.' 

More important, the effects of LSAPs do not seem to be 

restricted to Treasury yields. In particular, LSAPs have 

been found to be associated with significant declines 

in MBS yields and corporate bond yields as well as 

with increases in eqUity prices. 

Continued on next page 

1. For a ~electjve list of references regarding the effect of 

the first lSAP, see the box "The I::ffects of Federa! Reserve 

Asset Purchases" in Board of Governors of the Federa! 

Reserve System (2011), Monetary Policy Report to the 

Congress (Washington: Board of Governors, March), www. 

federalreserve.gov/monetarypo! icy/mpr _2011 0301_part2 .htm. 

For additional references, including those that analyze the 

effect of the second lSAP as well as the maturity extension 

program, see, for example, Stefania D'Amico, William 

English, David l6pez-Salido, and Edward Nelson (2012), "The 

Federal Reserve's large-Scale Asset Purchase Programmes: 

Rationale and Effects," Economic Journal, vol. 122 

(November), pro F415--45; Arvind Krishnamurthy and Annette 

Vissing-Jorgensen (2011), "The Effects of Quantitative fasing 

on Interest Rates: Channels and Implications for PoliCY," 

Brookings Papers on Economic Activity, Fall, pp. 215-65; 

Canlin li and Min Wei (2012), "Term Structure Modelltng 

with Supply Factors and the Federal Reserve's Large 

Scale Asset Purchase Programs," Finance and Economics 

Discussion Series 2012~37 (Washington: Board of Governors 

of the Federal Reserve System, May), www.federalreserve. 

gov/pubslfeds/2012/20123 71201237pap.pdf; and references 

in those studies. For work that specifically emphasizes the 

signaling channel of lSAPs, scc, for example, Michael D. 

Bauer and Glenn D. Rudebusch (2012), "The Signaling 

Channel for Federal Reserve Bond Purchases," Working Paper 

Serje~ 2011-21 (San Francisco: Federal Reserve Bank of San 

Francisco, August), www.frbsf.orglpublications/economics/ 

papersl2011/wp11~21 bk.pdf. For work that focuses on 

the effects on credit default risk, see, for example, Simon 

Gilchrist and Egon Zakrajsek (2012), "The Impact of the Federal Reserve's large-Scale Asset Purchase Programs on 

Default Risk" paper presented at "Macroeconomics and 

Financial Intermediation: Directions since the Crisis," a 

conference held at the National Bank of Belgium, Brussels, 

Decenlber 9~1 0,2011. Although the majority of research 

on the effects of LSAPs appears to support a significant 

influence on asset price'>, the overall result of such programs 

is generally difficult to estimate precisely: Event studies can 

make onty sharp predictions on the effects within a relatively 

short time horizon, whereas approaches based on timeseries models tend to face challenges in isolating the effects 

of the programs from other economic developments. For a 

more skeptical view on the effect of lSAPs, see, for example, 

Daniell. Thornton (2012), "Evidence on the Portfolio Balance 

Channel of Quantitative Easing," Working Paper Series 2012~ 

OlSA (S1. louis: Federal Reserve Bank of S1. louis, October), 

http://research.stlouisfed.orglwp/2012/2 0 12 -015.pdf. 
110 


80869.053

40 PART 2, MONETARY POLICY 

Efficacy and Costs of large-Scale Asset Purchases, continued 

While there seems to be substantial evidence that 

LSAPs have lowered longeHerm yields and eased 

broader financial conditions, obtaining accurate 

estimates of the effects of LSAPs on the macroeconomy 

is inherently difficult, as the counterfactual case-how 

the economy would have performed without LSAPs--

cannot be directly observed. However, econometric 

models can be used to estimate the effects of LSAPs 

on the economy under the assumption that the 

economic effects of the easier financial conditions 

that are induced by lSAPs are similar to those that 

are induced by conventional monetary policy easing. 

Model simulations conducted at the Federal Reserve 

have generally found that asset purchases provide 

a significant boost to the economy. For example, 

J study based on the Federal Reserve Board's 

FRB/US model estimated that, as of 2012, the first 

two rounds of LSAPs had raised real gross domestic 

product almost 3 percent and increased private payroll 

employment by about 3 million jobs, while lowering 

the unemployment rate about 1.5 percentage points, 

relative to what would have been expected otherwise. 

These simulations also suggest that the program 

materially reduced the risk of deflation.' 

Of course, all model-based estimates ofthe 

macroeconomic effects of LSAPs are subject to 

considerable statistical and modeling uncertainty 

and thus should be treated with caution. Indeed, 

while some other studies atso report signiflcant 

macroeconomic effects from asset purchases, 

other research finds smaller effects. 3 Nonetheless, 

2. These results are discussed further in Hess Chung, 

Jean-Philippe laforte, David Reifschneider, and John C. 

Williams (2012), "Have We Underestimated the likelihood 

and Severity of Zero Lower Bound Events?" Journal of Money, 

Credit and Banking, voL 44 (February supplement), 

pp.47-82. 

3. For studies reporting significant macroeconomic effects 

from asset purchases, see, for example, jeffrey C. Fuhrer and 

Giovanni P. Olivei (2011), "The Estimated Macroeconomic 

fffecfs of the Federal Reserve's large-Scate Treasury Purchase 

Program," Public Policy Briefs 11-02 (Boston: Federa! Reserve 

Bank of Boston, Apri!), www.bosJrb.orgieconomic/ppb/20111 

ppb112.pdf; and Christiane Baumeister and Luca Benat; 

(2012), "Unconventional Monetary Policy and the Great 

Recession: Estimating the Macroeconomic Effects of a Spread 

Compression at the Zero lower Bound," Working Papers 

2012-21 (Ottawa: Bank of Canada, July), wW\v.bankofcanada. 

calwp-contentJuploadsl2012/07/wp2012-21.pdf. Also, the 

Bank of England has implemented tSArs similar to those 

undertaken by the Federal Reserve, and its staff research finds 

that the effects appear to be quantitatively similar to those in 

the United States. 

For studies reporting smaller effects from asset 

purchases, see, for example, Michael T. Kiley (2012), 

a balanced reading of the evidence supports the 

conclusion that LSAPs have provided meaningful 

support to the economic recovery while mitigating 

deflationary risks. 

The potential benefits of LSAPs must be considered 

alongside their possible costs. One potential cost of 

conducting additional LSAPs is that the operations 

could lead to a deterioration in market functioning 

or liquidity in markets where the Federal Reserve 

is engaged in purchasing. More specifically, if the 

Federal Reserve becomes too dominant a buyer in 

a certain market, trading among private participants 

could decrease enough that market liquidity and 

price discovery become impaired. As the global 

financial system relies on deep and liquid markets 

for U.S, Treasury securities, significant impairment of 

this market would be especially costly; impairment 

of this market could also impede the transmission of 

monetary policy. Although the large volume of the 

Federal Reserve's purchases relative to the size of 

the markets for Treasury or agency securities could 

ultimately become an issue, few if any problems have 

been observed in those markets thus far, 

A second potential cost of LSAPs is that they may 

undermine public confidence in the Federal Reserve's 

ability to exit smoothly from its accommodative 

policies at the appropriate time. Such a reduction 

in confidence might increase the risk that long-term 

inflation expectations become unanchored. The 

Federal Reserve is certainly aware of these concerns 

and accordingly has placed great emphasis on 

developing the necessary tools to ensure that polley 

accommodation can be removed when appropriate. 

For example, the Federal Reserve will be able to 

put upward pressure on short-term interest rates at 

the appropriate time by raising the interest rate it 

pays on reserves, using draining tools !ike reverse 

repurchase agreements or term deposits with 

depository institutions, or selling securities from the 

Federal Reserve's portfolio. To date, the expansion of 

the balance sheet does not appear to have materially 

affected long-term inflation expectations. 

A third cost to be weighed is that of risks to 

financia! stability. For example, some observers have 

"The Aggregate Demand Effects of Short- and long-Term 

Interest Rates," Finance and Economics Discussion Series 

2012-54 (Washington: Board of Governors of the Federal 

Reserve System, August), www.federa!reserve.gov/pubsl 

feds/2012/2012541201254pap.pdf; and Han Chen, Vasco 

Curdia, and Andrea Ferrero (2012), "The Macroeconomic 

Effects of large-Scale Asset Purchase Programmes," Economic Journal, voL 122 (November), pp. F289-315. 
111 


80869.054

raised concerns that, by driving longer-term yields 

lower, nontraditional policies could induce imprudent 

risk-taking by some investors. Of course, some risktaking is a necessary element of a healthy economic 

recovery, and accommodative monetary policies 

could even serve to reduce the risk in the system 

by strengthening the overall economy_ Nonetheless, 

the Federal Reserve has substantially expanded its 

monitoring of the financial system and modified 

its supervisory approach to take a more systemic 

perspective. 

There has been limited evidence so far of excessive 

buildups of duration, credit risk, or leverage, but the 

Federal Reserve will continue both its careful oversight 

and its implementation of financial regulatory reforms 

designed to reduce systemic risk,4 

The Federal Reserve has remitted substantial 

income to the Treasury from its earnings on securities, 

totaling some $290 billion since 2009. However, 

if the economy continues to strengthen and policy 

accommodation is withdrawn, remittances will likely 

4. For additional details, see the box "The Federal Reserve's 

Actions to Fo~ter Financial Stability" in Part 1. 

MONETARY POLICY REPORT: FEBRUARY 2013 41 

decline in coming years, Indeed, in some scenarios, 

particularly if interest rates were to rise quickly, 

remittances to the Treasury could be quite low for 

a time,S Even in such scenarios, however, average 

annual remittances over the period affected by the 

Federal Reserve's purchases are highly likely to be 

greater than the pre~crisis norm, perhaps substantially 

so, Moreover, if monetary policy promotes a stronger 

recovery, the associated reduction in the federal 

deficit would far exceed any variation in the Federal 

Reserve's remittances to the Treasury, That said, the 

Federal Reserve conducts monetary policy to meet 

its congressionally mandated objectives of maximum 

employment and price stability and not primarily for 

the purpose of turning a profit for the u.s. Department 

of the Treasury 

5. For additional details, see Seth Bo Carpenter, Jane L 

Ihrig, Elizabeth C. Klee, Daniel W. Quinn, and Alexander 

I~. Boote (2013), "The Federal Reserve's Balance Sheet and 

farnings: A Primer and Projections," Finance and Economics 

Discussion Series 2013-01 (Washington: Board of Governors 

of the Federa! Reserve System, January), www.federalreserve. 

gov/pubsifeds12013/201301/201301 abs.html. 
112 


80869.055

42 PART 2, MONETARY POLICY 

In particular, the Committee indicated that it 

expected that the exceptionally low range for 

the federal funds rate would be appropriate 

at least as long as the unemployment rate 

remains above 6\-1 percent, inflation between 

one and two years ahead is projected to be 

no more than Ii, percentage point above the 

Committee's 2 percent longer-run goal, and 

longer-term inflation expectations continue to 

be well anchored. These thresholds were seen as 

helping the pnblic to more readily understand 

how the likely timing of an eventual increase in 

the federal funds rate would shift in response to 

nnanticipated changes in economic conditions 

and the ontlook. Accordingly, thresholds could 

increase the probability that market reactions 

to economic developments would move longerterm interest rates in a manner consistent 

with the Committee's assessment of thc likely 

future path of short-term interest rates. The 

Committee indicated in its December statement 

that it viewed the economic thresholds, at 

least initially, as consistent with its earlier, 

date-based guidance. The new langnage noted 

that the Committee would also consider other 

information when determining how long to 

maintain the highly accommodative stance of 

monetary policy, including additional measures 

of labor market conditions, indicators of 

inflation pressures and inflation expectations, 

and readings on financial developmcnts. 

At the conclusion of its January 29-30 meeting, 

the Committee made no changes to its target 

range for the federal funds rate, its asset 

purchase program, or its forward guidance for 

the federal funds ratc. The Committee stated 

that, with appropriate policy accommodation, it 

expected that economic growth wonld proceed 

at a moderate pace and the unemployment 

rate wonld gradually decline toward levels 

the Committee judges consistent with its 

dual mandate. It noted that strains in global 

financial markets had eased somewhat, but 

that it continued to sec downside risks to the 

economic outlook. The Committee continued 

to anticipate that inflation over the medium 

term likely would run at or below its 2 percent 

objective. 
113 


80869.056

43 

PART 3 

SUMMARY OF ECONOMIC PROJECTIONS 

The following material appeared as an addendum to the minutes of the December 77-72,2072, 

meeting of the Federal Open Market Committee. 

In conjunction with the December 11-12, 

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 of 

real output growth, the nnemployment rate, 

inflation, and the target federal funds rate for 

each year from 2012 through 2015 and over 

the longer run. Each participant's assessment 

was based on information available at the time 

of the meeting plus his or her judgment of 

appropriate monetary policy and assumptions 

about the factors likely to affect economic 

outcomes. The longer-run projections 

represent each participant's judgment of the 

value 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 each participant deems 

most likely to foster outcomes for economic 

activity and inflation that best satisfy his or 

her individual interpretation of the Federal 

Reserve's objectives of maximum employment 

and stable prices. 

Overall, the assessments submitted in 

December indicated that FOMC participants 

projected that, under appropriate monetary 

policy, the pace of economic recovery would 

gradually pick up over the 2012--15 period 

and inflation would remain subdued (table 1 

and figure I). Participants anticipated that the 

growth rate of real gross domestic product 

(GDP) wonld increase somewhat in 20]3 and 

again in 2014, and that economic growth in 

2014 and 2015 wonld exceed their estimates 

of the longer-run sustainable rate of growth, 

while the unemployment rate would decline 

gradually through 2015. Participants projected 

that each year's inflation, as measured by the 

annual change in the price index for personal 

consnmption expenditures (PCE), would run 

Table 1. Economic projections of Federal Reserve Board members and Federal Reserve Bank presidents, December 2012 

Percent 

Variable Longer 2012 2015 2012 2015 Longer run 

Change in rea! GDP .... 1.7 to 1.8 3.0 to 3.7 2.3 t02.5 1,6 to 2.0 2.0103.2 2.8 to 4.0 2.5 to 4.2 2.2t03.0 

September projecti{)n .. 1.7 to 2.0 2.5 to 3.0 3.0 to 3.8 3.0to 3.8 2.3 ta2.S 1.6102.0 2.3103.5 2.7104.1 2.5 t04.2 2.2 to 3.0 

Unemployment rate .. 7.8 t07.9 7.4 to 7.7 6.8 to 7.3 6.0 to 6.6 5.2 106.0 7.7 t08.0 6.9to 7.8 6.1 to 7.4 5.7 to 6.8 5.010 6.0 

September projection, ... 8..0108,2 7.6 to 7,9 6.7 to 7.3 6.0 to 6.8 5.2 to 6.0 8.0 to 8.3 7.0108.0 6.3 to 7,5 5.7t06.9 50to 6.3 

peE inflation .. 1.6 to 1.7 1.3 102,0 1.5102.0 L7 to 2.0 2.0 1.6 to 1.8 1.3 to 2.0 IAto 2.2 1.5 to 2.2 2.0 

September projection ... 1.7 to 1.8 1.6 to 2.0 1.6 to 2,0 2.0 Uto 1.9 1.5 to 2,1 1.6to 22 1.8 to 2.3 2.0 

Core peE inflation 1 .... L6toU 1,6101.9 1.6to 2.0 1.6 to 1.8 1.5 ta2.0 1.5 t02.0 1.7 to 2,2 
114 


80869.057

11 ;\\1' 

\ <1; 1\ 1 
115 


80869.058

close to or below the FOMe'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 next few 

years. In particular, 14 participants thought 

that it would be appropriate for the first 

increase in the target federal funds rate to 

occur during 2015 or later. Most participants 

judged that appropriate monetary policy 

would include purchasing agency mortgagebacked securities (MBS) and longer-term 

Treasury securities after the completion of the 

maturity extension program at the end of 2012. 

As in September, participants jndged the 

uncertainty associated with the outlook 

for real activity and the unemployment 

rate to be unusually high compared with 

historical norms, with the risks weighted 

mainly toward slower economic growth 

and a higher unemployment rate. While a 

number of participants viewed the uncertainty 

surrounding their projections for inflation 

to be unusually high, more saw the level of 

uncertainty to be broadly similar to historical 

norms; most considered the risks to inflation 

to be roughly balanced. 

The Outlook for Economic Activity 

Participants judged that the economy grew 

at a moderate pace over the second half of 

2012 and projected that, conditional on their 

individual assumptions about appropriate 

monetary policy, the economy would grow 

at a somewhat faster pace in 2013 before 

expanding in 2014 and 2015 at a rate above 

what participants saw as the longer-run rate 

of output growth. The central tendency of 

their projections for the change in real GOP 

in 2012 was 1. 7 to 1.8 percent, slightly lower 

than in September. A number of participants 

mentioned that last summer's drought and 

the effects of Hurricane Sandy likely had held 

down economic activity in the second half of 

this year. Many participants also noted that, 

MONETARY POLICY REPORT: FEBRUARY 2013 45 

while conditions in the housing and labor 

markets appeared to have improved recently, 

uncertainty about fiscal policy appeared to 

be holding back business and household 

spending. Participants' projections for 2013 

through 2015 were generally little changed 

relative to their September projections. The 

central tendency of participants' projections 

for real GOP growth in 2013 was 2.3 to 

3.0 percent, followed hy a central tendency of 

3.0 to 3.5 percent for 2014 and one of 3.0 to 

3.7 percent for 2015. The central tendency 

for the longer-run rate of increase of real 

GOP remained 2.3 to 2.5 percent, unchanged 

from September. Most participants noted 

that the high degree of monetary policy 

accommodation assumed in their projections 

would help promote the economic recovery 

over the forecast period; however, they also 

judged that several factors would likely 

hold back the pace of economic expansion, 

including slower growth abroad, a stillweak housing market, the difficult fiscal 

and financial situation in Europe, and fiscal 

restraint in the United States. 

Participants projected the unemployment 

rate for the final quarter of 2012 to be close 

to its average level in October and November, 

implying a rate somewhat below that projected 

in September. Participants anticipated a 

gradual decline in the unemployment rate over 

the forecast period; even so, they generally 

thought that the unemployment rate at the 

end of 2015 would still be well above their 

individual estimates of its longer-run normal 

level. The central tendencies of participants' 

forecasts for the unemployment rate were 

7.4 to 7.7 percent at the end of 2013, 6.8 to 

7.3 percent at the end of 2014, and 6.0 to 

6.6 percent at the end of 2015. The central 

tendency of participants' estimates of the 

longer-run normal rate of unemployment that 

would prevail under appropriate monetary 

policy and in the absence of further shocks to 

the economy was 5.2 to 6.0 percent, unchanged 

from September. Most participants projected 

that the unemployment rate would converge 
116 


80869.059

f( 

" 

H' 
117 


80869.060

to their estimates of its longer-run normal rate 

in five or six years, while a few judged that less 

time would be needed. 

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 rate 

of improvement in the housing sector, the 

spillover 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, the likely 

evolution of credit and financial market 

conditions, and longer-term trends in 

productivity and the labor force. With the data 

for much of 2012 now in hand, the dispersion 

of participants' projections of real GDP 

growth and the unemployment rate this year 

narrowed compared with their September 

submissions. Meanwhile, the distribution 

of participants' forecasts for the change in 

real GDP in 2013 shifted down a bit, and 

that for 2014 narrowed slightly. However, the 

range of projections for real GDP growth 

in 2015 was little changed from September. 

The distributions of the unemployment rate 

projections at the end of 2012, 2013, and 2014 

all shifted lower, while the range of projections 

for the unemployment rate for 2015, at 5.7 to 

6.8 percent, remained close to its September 

level. The dispersion of estimates for the 

longer-run rate of output growth stayed fairly 

narrow, with all but one between 2.2 and 

2.5 percent. The range of participants' 

estimates of the longer-run rate of 

unemployment, at 5.0 to 6.0 percent, narrowed 

relative to September. This range reflected 

different judgments among participants about 

several factors, including the outlook for labor 

force participation and the structure of the 

labor market. 

MONETARY POLICY REPORT: FEBRUARY 2013 47 

The Outlook for Inflation 

Participants' views on the broad outlook for 

inflation under appropriate monetary policy 

were little changed from September. Most 

anticipated that inflation for 2012 as a whole 

would be close to 1.6 percent, somewhat lower 

than projected in September. A number of 

participants remarked that recent inflation 

readings had come in below their expectations. 

Almost all of the participants judged that 

both headline and core inflation would remain 

subdued over the 2013-15 period, running at 

rates equal to or below the FOMC's longerrun objective of 2 percent. Specifically, the 

central tendency of participants' projections 

for inflation, as measured by the PCE price 

index, moved down to 1.3 to 2.0 percent for 

2013 and was little changed for 2014 and 2015 

at 1.5 to 2.0 percent and 1.7 to 2.0 percent, 

respectively. The central tendencies of the 

forecasts for core inflation were broadly similar 

to those for the headline measure for 2013 

through 2015. In discussing factors likely to 

sustain low inflation, several participants cited 

stable inflation expectations and expectations 

for continued sizable resource slack. 

Figures 3.C and 3.D provide information 

about the diversity of participants' views 

about the outlook for inflation. The range of 

participants' projections for headline inflation 

for 2012 narrowed from 1.5 to 1.9 percent 

in September to 1.6 to 1.8 percent in 

December; nearly all participants' projections 

in December were at 1.6 percent or 1.7 percent, 

broadly in line with recent inflation readings. 

The distributions of participants' projections 

for headline inflation in 2013 and 2014 shifted 

lower compared with the corresponding 

distributions for September, while the range of 

projections for core inflation narrowed slightly 

for both years. The distributions for core and 

overall inflation in 2015 were concentrated 

near the Committee's longer-run inflation 

objective of 2 percent, although somewhat less 

so than in Septem ber. 
118 


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120 


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122 


80869.065

52 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

Appropriate Monetary Policy 

As indicated in figure 2, most participants 

judged that exceptionally low levels of the 

federal funds rate would remain appropriate 

for sevcral more years. In particular, 

13 participants thought that the first increase 

in the target federal funds rate would not be 

warranted until 2015, and 1 judged that policy 

firming would likely not be appropriate until 

2016 (upper panel). The 13 participants who 

expected that the target federal funds rate 

would not move above its effective lower 

bound until 20 IS thought the federal funds 

rate would be I V. percent or lower at the 

end of that year, while the 1 participant who 

expected that policy firming would commence 

in 2016 saw the federal funds rate target at 

50 basis points at the end of that year. Five 

participants judged that an earlier increase in 

the federal funds rate, in 2013 or 2014, would 

be most consistent with the Committee's 

statutory mandate. Those participants judged 

that the appropriate value for the federal funds 

rate would range from Y2 to 2% percent at the 

end of 2014 and from 2 to 4 1

/, percent at the 

end of 2015. 

Among the participants who saw a later 

tightening of policy, a majority indicated that 

they believed it was appropriate to maintain 

the current level of the federal funds rate 

until the unemployment rate is less than or 

equal to 6V, percent. In contrast, a majority 

of those who favored an earlier tightening of 

policy pointed to concerns about inflation as 

a primary reason for expecting that it would 

be appropriate to tighten policy sooner. 

Participants were about evenly split between 

those who judged the appropriate path for the 

federal funds rate to be unchanged relative to 

September and those who saw the appropriate 

path as lower. 

Nearly all participants saw the appropriate 

target for the federal funds rate at the end of 

2015 as still well below its expected longerrun value. Estimates of the longer-run target 

federal funds rate ranged from 3 to 4Y:2 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 information on 

their views regarding the appropriate path 

of the Federal Reserve's balance sheet. Most 

participants thought it was appropriate for 

the Committee to continue purchasing MBS 

and longer-term Treasury securities after 

completing the maturity extension program 

at the end of this year. In their projections, 

taking into account the likely benefits and 

costs of purchases as well as the expected 

evolution of the outlook, these participants 

were approximately evenly divided between 

those who judged that it would likely be 

appropriate for the Committee to complete its 

asset purchases sometime around the middle 

of 2013 and those who judged that it would 

likely be appropriate for the asset purchases 

to continue beyond that date. In contrast, 

several participants believed the Committee 

would best foster its dual objectives by ending 

its purchases of Treasnry securities or all of 

its asset purchases at the end of this year 

when the maturity extension program was 

completed. 

Key factors informing participants' 

views of the economic outlook and the 

appropriate setting for monetary policy 

include their judgments regarding labor 

market conditions that would be consistent 

with maximum employment, the extent to 

which employment currently deviated from 

maximum employment, the extent to which 

projected inflation over the medium term 

deviated from the Committee's longer-term 

objective of 2 percent, and participants' 

projections of the likely time horizon necessary 

to return employment and inflation to 

mandate-consistent levels. Many participants 

mentioned economic thresholds based on the 

unemployment rate and the inflation outlook 

that were consistent with their judgments 
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80869.066

of when it would be appropriate to consider 

beginning to raise the federal funds rate. 

A couple of participants noted that their 

assessments of the appropriate path for the 

federal funds rate took into account the 

likelihood that the neutral level of the federal 

funds rate was somewhat below its historical 

norm. There was some concern expressed that 

a protracted period of very accommodative 

monetary policy could lead to imbalances in 

the financial system. It was also noted that 

because the appropriate stance of monetary 

policy is conditional on the evolution of real 

activity and inflation over time, 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 federal funds 

rate at the end of each calendar year from 

2012 to 2015 and over the longer run. As 

previously noted, most participants judged 

that economic conditions would warrant 

maintaining the current low level of the 

federal funds rate until 2015. Views on the 

appropriate level of the federal funds rate by 

the end of 2015 varied, with 12 participants 

seeing the appropriate level of the federal 

funds rate as 1 percent or lower and 4 of them 

seeing the appropriate level as 2V, percent or 

higher. Generally, the participants who judged 

that a longer period of very accommodative 

monetary policy would be appropriate were 

those who projected that a sizable gap between 

the unemployment rate and the longer-run 

normal level of the unemployment rate would 

persist until 2015 or later. In contrast, the 

majority of the 5 participants who judged that 

policy firming should begin in 2013 or 2014 

indicated that the Committee would need to 

act relatively soon in order to keep inflation 

near the FOMe's longer-run objective of 

2 percent and to prevent a rise in inflation 

expectations. 

MONfTARY POLICY REPORT: FEBRUARY 20]3 53 

Table 2. Average historical projection error ranges 

Percentage points 

Variable 2012 2015 

Change in real GDPl. ±O.6 ±1.7 

Unemployment rate l iO.2 ±O.9 ±1.5 ±1.9 

Tolal consumer prices) .. ±O.S ±O.9 ±1.1 1-1.0 

:--JOTE: Error ranges shown arc measured as plus or minus tbe root 

mean squared error of projections for 1992 through 201! that were 

released in the fall by various private and government forecasters. As 

described in tbe box "Forecast Uncertainty," under certain assumptions. 

there is about a 70 percent probability that actual outcomes fllf real GDI>, 

unemployment, and consumer prices will be in ranges implied by the 

average size of projection errors made in the past. Further information 

may be found in David Reifschneider and Peter Tulip (2007), "Gauging 

the Uncertainty of the Economic Outlook from Historical Forecasting 

Errors," Finance and Economics Discussion Series 2007-60 (Washington: 

Board of Govemors of the Federal Reserve System, November). 

L Definitions of wriablcs are in the general note to table L 

2. Measure is the overall consumer price index, the price measure that 

has been most widely used in government and private economic forecasts 

Projection is percent change. fourth quarter of the previous year to the 

fourth quarter of the year indicated. 

Uncertainty and Risks 

Nearly all of the participants judged their 

current levels of uncertainty about real GDP 

growth and unemployment to be higher than 

was the norm during the previous 20 years 

(figure 4).' Seven participants judged that the 

levels of uncertainty associated with their 

forecasts of total PCE inflation were higher 

as well, while another 10 participants viewed 

uncertainty about inflation as broadly similar 

to historical norms. The main factors cited 

as contributing to the elevated uncertainty 

ahout economic outcomes were the difficulties 

involved in predicting fiscal policy in the 

United States, the continuing potential for 

European developments to threaten financial 

stability, and the possibility of a general 

slowdown in global economic growth. As in 

September, participants noted the challenges 

associated with forecasting the path of the 

1. 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 through 2011. 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, 
124 


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126 


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56 PART 3: SUMMARY OF ECONOMIC PROJECTIONS 

u.s. economic recovery following a financial 

crisis and recession that differed markedly 

from recent historical experience. A number 

of participants also commented that in the 

aftermath of the financial crisis, they were 

more uncertain about the level of potential 

output and its rate of growth. It was noted 

that some of the uncertainty about potential 

output arose from the risk that a continuation 

of elevated levels of long-term unemployment 

might impair the skills of the affected 

individuals or cause some of them to drop out 

of the labor force, thereby reducing potential 

output iu the medium term. 

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 US. fiscal policy, which many 

participants thought had the potential to slow 

economic activity significantly over the near 

term, and the situation in Europe. 

Most participants continued to judge the risks 

to their projections for inflation as broadly 

balanced, with several highlighting the recent 

stability of longer-term inflation expectations. 

However, three participants saw the risks to 

inflation as tilted to the downside, reflecting, 

for example, risks of disinflation that could 

arise from adverse shocks to the economy that 

policy would have limited scope to offset. A 

couple of participants saw the risks to inflation 

as weighted to the upside in light of concerns 

about US. fiscal imbalances, the current highly 

accommodative stance of monetary policy, 

and uncertainty about the Committee's ability 

to shift to a less accommodative policy stance 

when it becomes appropriate to do so. 
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80869.070

Forecast Uncertainty 

The economic projections provided by the 

members of the Board of Governors and the 

presidents of the Federal Reserve 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 unforeseen 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 

accuracy of a range of forecasts, including those 

reported in past Monetary Policy Reports and those 

prepared by the Federal Reserve Board's staff in 

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 rea! gross 

domestic product (CDP) and total consumer prices 

will rise steadily at annual rates of, respectively, 

3 percent and 2 percent. If the uncertainty attending 

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 CDP would expand within a range of 2.4 to 

3,6 percent in the current year, 1,6 to 4.4 percent in 

the second year, and 1.3 to 4.7 percent in the third 

MONETARY POliCY REPORT: FEBRUARY 2013 57 

and fourth years, 'Ihe corresponding 70 percent 

confidence intervals for overall inflation would 

be 1.5 to 2,5 percent in the current year, 1,1 to 

2.9 percent in the second year, 0,9 to 3.1 percent in 

the third year, and 1,0 to 3,0 percent in the fourth 

year. 

Because current conditions may differ from 

those that prevailed, on average, over history, 

participants provide judgments as 10 whether the 

uncertainty attached to their projections of each 

variable is greater than, smaller than, or broadly 

similar to typical levels of forecast uncertainty 

in the past, as shown in table 2, Participants also 

provide judgments as to whether the risks to their 

projections are weighted to the upside, are weighted 

to the downside, or are broadly balanced. That is, 

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 rather than 

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 is subject 

to considerable uncertainty. This uncertainty arises 

primarily because each participant's assessment of 

the appropriate stance of monetary policy depends 

importantly on the evolution of real activity and 

inflation over time, 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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80869.071

ABBREVIATIONS 

ABCP 

AFE 

BHC 

CDS 

C&I 

CMBS 

CP 

CRE 

DPI 

ECB 

EME 

E&S 

FOMC 

GDP 

MBS 

MEP 

MMF 

NIPA 

OMT 

PCE 

REIT 

repo 

SEP 

SLOOS 

S&P 

TALF 

asset -backed commercial paper 

advanced foreign economy 

bank holding company 

credit default swaps 

commercial and industrial 

commercial mortgage-backed securities 

commercial paper 

commercial real estate 

disposable personal income 

European Central Bank 

emerging market economy 

equipment and software 

Federal Open Market Committee; also, the Committee 

gross domestic product 

mortgage-backed securities 

maturity extension program 

money market fund 

national income and product accounts 

Outright Monetary Transactions 

personal consumption expenditures 

real estate investment trust 

repurchase agreement 

Summary of Economic Projections 

Senior Loan Officer Opinion Survey on Bank Lending Practices 

Standard and Poor's 

Term Asset-Backed Securities Loan Facility 

59 
129 


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Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System, from Representative Bachus: 

1. During consideration of Dodd-Frank, one of the few bi-partisan amendments adopted 

states that in the case of foreign financial companies nnder section 165, that the Federal 

Reserve Board was required to "take into account the extent to which the foreign financial 

company is subject on a consolidated basis in the US." In proposing your recent section 

165 rule for foreign banks, press reports indicate that there are over 100 foreign banks 

covered. With that in mind --

a. How many countries are covered by these 100+ foreign banking organizations? 

The standards in section 165 generally apply to foreign banking organizations that have a U.S. 

banking presence and total consolidated assets of $50 billion or more. There are foreign banking 

organizations operating in the United States from 33 countries in this category. 

The standards in section 165 related to stress tests apply to foreign banking organizations with a 

U.S. banking presence and total consolidated assets of more than $10 billion. Including the 

foreign banking organizations described above, there are foreign banking organizations operating 

in the United States from 46 countries that have total consolidated assets of more than 

$10 billion. 

b. Did you perform the required Dodd-Frank comparability analysis of the home country 

standards for each of these countries as they are heing applied to firms on a consolidated 

basis? 

The Board has not yet taken final action on its proposal regarding the US operations of foreign 

banking Qrganizations and continues to evaluate the issues and comments raised by that proposal. 

The Board's proposal recognizes that home country supervisors impose standards on foreign 

banks. For example, the proposal does not impose capital requirements on branches or agencies 

of a foreign bank; rather, it looks to whether the foreign bank meets capital adequacy standards 

at the consolidated level that are consistent with Basel capital adequacy standards. In addition, 

the proposed risk management standards would provide flexibility for foreign banking 

organizations to rely on home country governance structures, and would allow foreign banking 

organizations to meet proposed stress testing requirements for branches and agencies at the 

consolidated level (provided the home country maintains stress testing requirements that are 

broadly consistent with U.S. requirements). 

With respect to most other enhanced prudential standards that the Board is required by statute to 

impose (e.g., liquidity requirements, single-counterparty credit limits, overall risk management, 

stress testing, and early remediation), international standards have either not yet been adopted in 

national jurisdictions or are not yet fully developed. As a result, international requirements vary 

widely. 

Finally, it is important to note that section 165 requires the Board to consider risks to financial 

stability and the principle of national treatment, in balance with the comparability of home 
130 


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-2-

country standards. The proposal is designed to mitigate risks to financial stability posed by large 

foreign banks by adjusting the Board's current regulatory approach to address the increased 

complexity and risk profile of the U.S. operations of these foreign banks. The proposal gives 

due regard to the principle of national treatment by proposing standards for large foreign banks 

that are broadly consistent with those proposed for U.S. banking organizations under 165, such 

that U.S. banking organizations are not put at a competitive disadvantage. 

The Board is carefully weighing the comments that it has received on this proposal as well as the 

effects of the proposal on financial stability and the principles of competitive equality and 

national treatment in the United States. 

c. If so, can you provide the Committee your country by country analysis including an 

identification of gaps where individual home country regulations fell short of US or global 

standards? If such an analysis was not done, can you explain why it was not given the 

express direction in Dodd-Frank? 

The Dodd-Frank Act requires the Board to take into account the extent to which a foreign 

financial company is subject on a consolidated basis to home country standards that are 

comparable to those applied to financial companies in the United States. Please see the answer 

for question 1 part b. 

2. Many of the foreign banking organizations covered by your 165 rule do not own an 

insured bank and only operate in the US via a broker-dealer. 

a. In establishing capital and other standards for these firms, did the Fed staff consult with 

the SEC technical staff on a bilateral basis? 

Yes. Federal Reserve staff consulted with SEC staff, as well as staff of the other FSOC member 

agencies, prior to issuing the proposal. 

b. Did the SEC indicate to the Fed that they believe that current broker-dealer capital or 

other standards are inadequate? 

SEC and Fed staff did not discuss the adequacy of current broker-dealer capital regulations or 

other standards. 

c. Section 165(b )(3) of Dodd-Frank says that in prescribiug these standards, the Fed 

should also take into account whether a foreign bank owns an insured bank as well as 

whether it has another primary regulator. Did you take either ofthese factors in to 

account when evaluating the situation of foreign bank not owning an insured bank & 

engaged in primarily broker-dealer operations that are regulated by the SEC? If not, why 

not? 
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-3-

In proposing the standards, the Board considered the extent to which foreign banking 

organizations own U.S. insured depository institutions and adjusted the proposal to take into 

account the different types of banking operations a foreign banking organization might have in 

the United States. In order to be subject to the proposal, a foreign bank must have a banking 

presence in the United States--either through ownership of an insured depository institution or 

through operation ofU.8. branches or agencies. A foreign bank that has a banking presence 

through a U.S. branch or agency (in lieu of or in addition to operating an insured depository 

institution) would be permitted to continue to operate the branch or agency outside of the 

intermediate holding company, and the branch or agency would generally be permitted to 

continue to meet capital levels at the consolidated level as set by the foreign supervisor of the 

foreign bank. 

The Board also considered the extent to which the U.S. operations of a foreign banking 

organization are regulated by the SEC. As noted above, the proposal would not apply 

requirements to individual broker-dealer subsidiaries. The proposal would apply requirements to 

the consolidated U.S. intermediate holding company of a foreign banking organization, in line 

with the Federal Reserve's responsibility to supervise and regulate the overall U.S. operations of 

foreign banking organizations. 

3. In recent discussions with EU representatives, it has been stated that the EU was 

completely blindsided by the 165 proposal. 

a. Can you identify which international regulators the Fed consulted with in formulating 

this proposal? 

Board members and staff have met with numerous foreign regulators to discuss the details of and 

concems about the proposaL The Board has also received a number of written comments from 

foreign regulators. Consistent with past practice, the Board has provided a long comment period 

on this proposal, which has allowed all members of the public, including foreign bank regulators, 

an opportunity to provide detailed feedback on the proposaL The Board will carefully consider 

all comments received during the public comment period, including those received from foreign 

regulators, prior to fmalizing all rules. 

b. Do these foreign regulators believe that their home country standards are not 

comparable to US standards or are otherwise inadequate? 

We have received comments from a number of foreign regulators. These regulators have 

encouraged the Federal Reserve to place greater emphasis on the comparability of their standards 

in the U.S. rules. 

c. Do you believe that implementation of the Fed's regime will lead to enhanced or 

diminished cooperation between intcrnational regulators? 
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-4-

The Federal Reserve works hard to foster cooperation between international regulators, and 

actively participates in international efforts to improve cooperation among supervisors around 

the world. As a general matter, supervisors around the world have responded to the lessons 

learned in the latest financial crisis by improving the supervisory and regulatory standards that 

apply to their banking organizations. We have been working with our international counterparts 

to develop common approaches to increasing the financial strength of our respective financial 

organizations and the financial stability of our respective economies. While these efforts often 

lead to unified approaches, such as the Basel III capital framework, it is also true that countries 

move at different paces and develop supplemental solutions that are tailored to the unique legal 

framework, regulatory system, and industry structure in each country. For example, the United 

States has long been one of the only countries that applies a leverage ratio to its banking 

organizations, and the United States has long had different activity restrictions for banking firms 

than exist in other countries. 

Further, Basel agreements allow host jurisdictions to apply their prudential requirements to 

locally incorporated subsidiaries offoreign banking organizations. As a result, U.S. banking 

organizations already operate in a number of overseas markets that apply Basel risk -based capital 

requirements to their local commercial banking and investment banking activities. In addition, 

the U.K., which is host to substantial operations of U.S. banking organizations, applies local 

liquidity standards to commercial banking and investment banking subsidiaries of non-U.K. 

banks operating in their market. 

As regulatory and supervisory standards are implemented throughout the world, we and our 

international supervisory colleagues will gain further insight into which approaches are most 

effective in improving the resilience of banking organizations and in protecting financial 

stability, and we will take further action as appropriate. 
133 


80869.076

Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System, from Representative Fitzpatrick: 

1. Since the Fed has embarked on, and has continued, a bond-buying program to maintain 

economic stimulus, what is a prospective sale strategy for the acquired positions? The 

sheer magnitude of the "Q-finity" purchases in the multi-billions of dollars leaves open 

possibility of market destabilization on the un-winding of these positions. Is there a 

strategy of holding positions until maturities? Or have target prices been set to assure that 

global bond markets are minimally affected upon any future Fed sales prior to maturity? 

How will the Fed maintain fixed-income market confidence so that access consumer credit 

at reasonable prices is assured? 

In the minutes to the June 2011 FOMC meeting, the Committee elaborated a strategy for the 

eventual nonnalization of the stance of monetary policy when tinning the stance of monetary 

policy once such a change is judged to be appropriate. In that strategy, the FOMC noted that it 

will primarily rely on changes to the FOMC's target for the federal funds rate as the tool for 

managing monetary policy. 

The Committee also noted that it intended to use the payment of interest on reserves as the key 

instrument to ensure that the federal funds rate and other money market rates remain close to the 

target. The FOMC noted that it would likely use reserve draining tools to support the payment 

interest on reserves as a tool, as necessary. 

The minutes from that meeting also noted that the FOMC has considered selling its holdings of 

mortgage-backed securities (MBS) after the target for the federal funds rate has been increased. 

Any such sales would be gradual and arrnounced well in advance so as to minimize their effects 

on financial market conditions. 

The Committee noted, however, that it might change its strategy for the nonnalization of 

monetary policy if there were changes in economic or fmancial market conditions. At the press 

conference following the June 2013 FOMC meeting, I reported that there was general agreement 

among FOMC participants that sales ofMBS would not be necessary for the finning of the 

stance of monetary policy and the sales could possibly cause some deterioration in market 

functioning. As a result the sales of MBS during the nonnalization of policy would be unlikely, 

although once monetary policy has been nonnalized, some sales to eliminate residual holdings of 

MBS might be possible. 

2. As credit has been eased to provide stimulus in this and other Fed actions, there are 

inherent resulting inflationary pressures which may force a Fed response of higher shortterm interest rates. Inflationary signals also trigger bond price changes farther out on the 

duration and maturity curves. Has the Fed boxed itself in by buying longer bonds whose 

prices would decline due to anticipated inflation prospects (leading to higher interest rates), 

leaving a less valuable asset portfolio providing less collateral value for Fed strategic 

purposes in coming years? 
134 


80869.077

-2-

Price stability is one of the FOMe's two statutory mandates; maximum employment is the other. 

The FOMC has interpreted price stability by setting a longer-mn objective for inflation of2 

percent, based on the price index for personal consumption expenditures. 

Currently, inflation is below the FOMe's target of2 percent, and the FOMC anticipates that 

inflation will run at or slightly below its target over the medium term. The FOMC anticipates 

that longer-term interest rates will rise over time as the economy recovers and it eventually 

moves to normalize the stance of monetary policy. A consequence of those higher longer-term 

interest rates will be a reduction in the market value of the fixed income securities in the 

FOMC's portfolio. As of the end of May, the portfolio was in an unrealized gain position of just 

under $200 billion. 

Federal Reserve accounting only realizes gains or losses when securities are sold, and those 

gains or losses would directly affect Federal Reserve income. Umealized gains or losses do not 

have a direct effect on Federal Reserve income. In neither case would losses affect Federal 

Reserve actions or the conduct of monetary policy. 

In particular, the FOMC has stated that it intends to use increases in the target for the federal 

funds rate as its primary means of firming the stance of policy when it judges that such a change 

in policy is appropriate. The FOMC has also noted that it intends to rely on the interest rate on 

excess reserves as well as temporary reserve draining tools to ensure that the federal funds rate 

and other money market rates remain near the target We are confident that we have the tools we 

need to tighten policy when it becomes appropriate to do so. The market value of the FOMC's 

portfolio will not have a direct effect on the conduct of monetary policy. 
135 


80869.078

Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System, from Representative Garrett: 

1. Many countries peg their currencies to the U.S. dollar and therefore have to follow the 

direction of U.S. monetary policy. Have Fed actions created global imbalances that we are 

not fully appreciating when we examine the costs of our current loose monetary policy? 

One of the effects of this policy is that world has been flooded with dollars, and some 

foreign central banks have responded by depreciating their currencies relative to the 

dollar. What has been the practical effect of the QE regime on the exchange rate of the 

dollar? To what extent is the Fed concerned that exporting its easy money policy to the 

rest of the world could lead to a potentially destabilizing effect on world currencies? 

There are actually only a few countries that literally "peg their currencies to the dollar." 

Exchange rates of most advanced economies are largely market-determined, and even among 

emerging market economies, exchange rates have become more flexible over the last several 

decades. Of course, some countries, including China, still maintain highly managed exchange 

rates relative to the dollar. 

The Federal Reserve's accommodative monetary policy is focused on easing domestic financial 

conditions with the goal of stimulating spending by U.S. households and firms. Any effects of 

this policy on the foreign exchange value of the dollar are ancillary and probably relatively 

modest, as monetary policy in many of our trading partners has also been eased in response to 

weak recoveries and high unemployment. All told, the average value of the dollar against the 

currencies of our trading partners, in price-adj usted terms, is at about the same level as it was in 

mid-2008, before the global financial crisis intensified. To be sure, the dollar has fluctuated over 

this period, but its swings likely owe more to factors such as shifts in investor risk aversion than 

to shifts in monetary policies here or abroad. 

2. In addition, are you concerned that the Fed's easy money stance could be resulting in 

"hot flows" of capital to emerging markets, ultimately creating greater financial instability 

both domestically and abroad? What are the choices faced by emerging market economies 

when faced with "hot flows" of U.S. dollars? 

While many economies have challenges in a world of volatile international capital flows, it is not 

clear that accommodative policies in advanced economies impose net costs on emerging market 

economies ("EMEs"). 

To be sure, accommodative monetary policies in advanced economies such as the United States 

tend to reduce their interest rates relative to those of EMEs and thus encourage private capital 

flows to EMEs. But the evidence does not support the view that advanced-economy monetary 

policies are the dominant factor behind emerging market capital flows. In recent years, the 

relatively favorable economic growth prospects of the EMEs likely have been a major factor 

behind these flows. And, over the past few years, swings in international investor sentiment 

have also led to corresponding swings in EME capital flows. 

In addition, the effects of capital flows, whatever their cause, are not predetermined but depend 

on the choices made by policymakers in the recipient countries. Allowing more flexible 
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exchange rates can both diminish these inflows, by damping expectations of future currency 

appreciation, and help to mitigate the effects of capital inflows on domestic financial conditions. 

In contrast, systematically resisting pressures for exchange rate appreciation through exchange 

market intervention can result in more unwanted capital flows, possibly fueling domestic 

inflation in economies already near over-heating. 

Finally, the Federal Reserve's accommodative policies confer real benefits on other countries. 

Economic growth in emerging market economies slowed last year, in part reflecting a 

deterioration of their exports to the United States and other advanced economies. Monetary 

easing that supports the U.S. and other advanced economies should stimulate trade and growth in 

the emerging economies as well. 

3. I am growing increasingly concerned about the very real effects of the Fed's loose 

monetary policy. Since December 2008, the FOMe has held the Fed Funds rate at the zero 

bound, and these low rates have been chased with three rounds of quantitative easing and 

as well as "Operation Twist." As we look broadly at the financial markets, these low rates 

are forcing financial institutions to chase higher yields. For example, companies are 

issuing records amount of junk bonds as well as riskier covenant-lite corporate loans. Last 

year, we saw some $274 billion worth of junk bonds issued, representing a 55 percent 

increase from the prior year, and seven-fold increase in covenant-lite corporate loan 

volume since 2010. We have seen some financial market participants, such as Pimeo, warn 

that valuations on some of these asset classes are extreme. Fed Reserve Governor Jeremy 

Stein has stated, "we should be humble about our ability to see the whole picture, and 

should interpret those cIues that we do see accordingly." How do you interpret these clues? 

How has the Fed's easy money policy driven these asset bubbles? At what point will the 

Fed know to put on the brakes and raise interest rates? 

The staff at the Federal Reserve Board carefully monitors financial markets for signs of valuation 

and other pressures. In addition, as noted in my speech on financial monitoring on May 10, staff 

also consider whether assets that appear to be subject to pressures are being funded with 

dangerously high degrees of financial leverage or through structures resulting in potentially 

destabilizing levels of maturity transformations, as well as whether such assets are significantly 

illiquid or sensitive to changes in financial conditions. The presence of these financial-system 

vulnerabilities are essential for making a determination that adjustments in asset prices could be 

amplified by asset fire sales and other coordination problems with consequent adverse effects on 

the financial system. For example, the absence of high levels ofleverage helps to explain why 

the sizeable losses in the stock market in 2000 and 2001 had a far smaller impact on broader 

financial markets than the collapse of housing prices and prices of mortgage-related assets in 

2008, which spurred a systemic crisis. 

With respect to the high-yield and leveraged loan markets, we are aware of the pressures 

highlighted in your letter and will continue to monitor very carefully these and other financial 

market developments. If an assessment is made that financial system vulnerabilities are 

significant, the first line of defense, as noted in my May speech, will be the development of 
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macroprudential policy tools. Monetary policy, as you know, continues to be governed by the 

dual mandate of maximum employment and price stability. 

4. You have said that the Fed's mouetary policy actious earlier this decade (i.e. 2003-2005) 

did not contribute to the housiug bubble iu the U.S. But as I uuderstand it, you are now 

using monetary policy actions, particnlarly your QE program, to boost U.S. asset prices 

(for example, equities and real estate prices). How can both of these things be true? 

During 2003, the FOMe lowered the target federal funds rate to 1 percent, in the context of 

persistently elevated unemployment and undesirably low readings on core inflation. Over the 

next several years, monetary policy gradually tightened as the labor market strengthened and 

inflation moved up. These policy responses were consistent with the Federal Reserve's mandate 

to pursue maximum sustainable employment in the context of price stability. Over the same 

period, unfortunately, house prices in the United States became unmoored from their long-run 

fundamentals, primarily as a result of poor mortgage underwriting standards that allowed too 

many unqualified borrowers to obtain credit on terms that, ultimately, they could not sustain. In 

hindsight, better prudential supervision of mortgage lending and fmancial institutions more 

broadly might have been able to check the housing bubble, and thus the severe fallout from its 

collapse starting in 2008. Such a supervisory action would have been targeted on the source of 

the housing bubble (excessive mortgage lending) without having an unduly adverse effect on the 

rest of the economy. In contrast, if the FOMe had tried to prevent the housing bubble tluough 

tighter monetary policy, the Federal Reserve would likely have caused a marked weakening in 

overall economic activity and employment and pushed inflation down to an undesirable level 

during the 2003 to 2007 period, especially as it probably would have taken a large increase in 

interest rates to materially check the rise in house prices. 

Today, we are in a situation in which the real economy is persistently weak, the unemployment 

rate remains well above its normal level, and inflation is running below the FOMC's long-run 

goal of2 percent. Under such circumstances, it is appropriate that the FOMe pursue a highly 

accommodative monetary policy intended to lower borrowing costs and improve financial 

conditions more generally, including higher corporate equity prices; these improvements in 

financial market conditions should in tum help to support the economic recovery and bring 

inflation closer to its desired level. This general strategy is the same as that followed during 

previous economic downturns, and asset purchases simply represent an additional tool to put 

further downward pressure on long-term interest rates. As you note, the FOMe's current policy 

does indeed appear to be strengthening the housing market and helping to boost house prices. 

This development is not undesirable, however, because mortgage underwriting standards are 

tight, access to mortgage credit is limited, and house prices are, if anything, lower than 

fundamentals might suggest. Similarly, corporate equities do not appear overvalued despite their 

significant rise over the past few years because firms are enjoying a high level of profitability. 

That said, the Federal Reserve is diligently monitoring financial market developments for any 

signs of emerging imbalances, and will use all its tools as necessary to preserve the stability of 

the financial system while carrying out its dual-mandate responsibilities. 
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S. You're undoubtedly familiar with Milton Friedman's work, indicating that people 

consume off of what they view as their "permanent income," not just on changes in the 

value of volatile financial assets like stock prices. Economists are well aware that even a 

1 % change in the value of the stock market has historically affected Gnp growth by only a 

few hundreds of 1 %. Given how much you and other Fed governors point to elevated stock 

prices as an indicator of the effectiveness of quantitative easing, why do you think that the 

benefits to the economy outweigh the risk of creating excessive speculation-particularly 

because the Fed has repeatedly contributed to speculation that has ended very badly over 

the past decade? 

The Federal Reserve's purchases oflonger-term assets boost equity prices by reducing the 

interest rates investors use to discount future dividends and increasing expected future dividends 

as a result of stronger economic activity. Such gains in equity prices reflect shifts in 

fundamentals, not speculation. While, as you note, the resulting increase in household 

consumption owing directly to higher stock market wealth is likely modest, the asset purchases 

increase economic activity through a variety of channels and the combined effect on economic 

activity is considerable. 

At the same time, one of the potential costs of assets purchases is that they will contribute to 

financial instability, perhaps by encouraging investors to take on risks that they do not fully 

understand or by engendering increases in asset prices that are not supported by fundaments and 

could be quickly reversed in a destabilizing manner. We are closely monitoring these risks but 

currently do not judge there to be any widespread undesirable increase in risk taking or 

misalignment of asset prices with fundamentals. 

6. As oflast week, the U.S. monetary base has grown to more than 18 cents per dollar of 

nominal Gnp. The only other time the monetary base got even to 17 cents per dollar of 

Gnp was in the 1940's during World War II. The Federal Reserve didn't reserve that. 

Instead, consumer prices shot up 80% by 1952. Given that restoring even 2% Treasury 

bill rates would require cutting the Fed's balance sheet in half, why are you convinced that 

continuing to expand the monetary base has less risk to the economy that the historic 

monetary tightening that would be required if the Federal Reserve ever - ever - has to go 

in the opposite direction? 

The growth in the monetary base in recent years reflects the Federal Reserve's large-scale asset 

purchase programs. As the portfolio of assets held by the Federal Reserve increases, reserve 

balances, which are included in the monetary base and are a liability of the Federal Reserve, have 

risen by roughly the same amount. The growth in reserve balances is a byproduct, not the 

objective, of the asset purchases. The Federal Reserve's asset purchases are designed to lower 

longer-term interest rates by reducing the supply ofionger-term assets in private hands. The 

lower longer-term interest rates stimulate economic activity, improving the employment situation 

and reducing disinflationary pressures. 

When the Federal Reserve concludes that it is appropriate to tighten monetary policy to maintain 

full employment and stable prices, it will do so primarily by raising the interest rate paid on 
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reserve balances, which will put upward pressure on other short term interest rates, reducing the 

amount of monetary stimulus. The Federal Reserve could also engage in temporary reserve 

draining operations if needed to tighten the relationship between money market interest rates and 

the interest rate on reserve balances. 

Because the Federal Reserve has the tools necessary to tighten policy when appropriate, the risk 

that the Federal Reserve would be unable in the future to prevent an unwanted rise in inflation is 

low. By contrast, if the Federal Reserve were to refrain from taking necessary steps now to 

stimulate the economy at a time when the unemployment rate is elevated and inflation is below 

the FOMC's target, the risks of a pernicious disinflation would be significant. 

7. As oflast week, the Federal Reserve's consolidated balance sheet indicated that the 

Federal Reserve has capital of less than $55 billion, but assets of more than $3 trillion, 

mostly in long-term bonds. This puts the Fed at a leverage ratio of nearly 55-to-1. Now, 

assuming that the average maturity of those bonds is more than a few years, it only takes 

an increase in interest rates of about one-quarter of one percent to wipe out $55 billion in 

capital. What would be the effect of an increase in interest rates on the Fed's balance sheet 

and how would that affect Fed remittances back to the Treasury? 

Reserve Bank capital is not analogous to the capital of private-sector financial firms. Under the 

Federal Reserve Act, member banks are statutorily required to subscribe to Reserve Bank capital 

in direct proportion to the member banks' capital. The Reserve Banks retain earnings to create a 

surplus capital account that is equal to the capital paid in by the member banks. Reserve Bank 

capital does not confer control in the way that private-sector capital does. 

Reserve Bank capital also differs from private-sector capital in the event of a loss. In the event 

that Reserve Bank income is insufficient to cover interest expense, operating costs, and any loss 

that may occur, remittances to the Treasury cease. Remittances do not resume until such a time 

that Reserve Bank earnings are sufficient cover interest expense, operating costs, and any losses 

that have been incurred. The value of those suspended outlays is booked as a deferred asset. 

Because the Reserve Banks are able to take account of future earnings, Reserve Bank capital 

does not fall in the event of a loss. 

Because Reserve Bank capital differs fundamentally from private-sector capital, conventional 

measures ofleverage are not applicable. 

8. As you are aware, the Financial Stability Oversight Council (FSOC) will convene its 

next regularly scheduled meeting on Thursday, February 28, 2013. Along with many 

others, I am very concerned about the transparency of FSOC. I know that you aware that 

the Government Accountability Office (GAO) issued a report last September that clarified 

concerns that many of us on the Committee have with respect to FSOC transparency. 

Specifically, the GAO noted that FSOC needs to create a better system of coordination 

between disparate agencies, keep records of closed-door meetings, share more information 

with the public, as well as engage outside stakeholders. The GAO also expressed concerns 

of the Office of Financial Research, the organization dedicated to producing financial data 
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that can be used to gauge risk. As Chairman of an organization that has faced similar 

criticisms in the past regarding transparency, what do you believe that FSOC can do to 

improve its transparency, especially given FSOC's authority to designate financial 

institutions as "too-big-to-fail"? 

The Financial Stability Oversight Council ("Council") is firmly committed to promoting 

transparency and accountability in connection with its activities. In November 2012, the Council 

and the Office of Financial Research jointly provided a response to Congress and the GAO with 

a description of the actions planned and taken in response to each of the recommendations in the 

report. The report made a number of constructive recommendations on ways in which the 

Council could further enhance its transparency, including improving the Council's website. 

Subsequently, the Council's website was reintroduced, in December 2012, to improve 

transparency and usability, to improve access to Council documents, and to allow users to 

receive e-mail updates when new content is added. The Council is firmly committed to holding 

open meetings and closes its meetings only when necessary. However, the Council must 

continue to find the appropriate balance between its responsibility to be transparent and its 

central mission to monitor emerging threats to the financial system. Council members frequently 

discuss supervisory and other market-sensitive data during Council meetings, including 

information about individual firms, transactions, and markets that require confidentiality. In 

many instances, regulators or firms themselves provide nonpublic information that is discussed 

by the Council. Continued protection of this information, even after a period oftime, is often 

necessary to prevent destabilizing market speculation or other adverse consequences that could 

occur if that information were to be disclosed. 

9. On a recent member delegation trip, I visited Germany's central bank-the Budesbank. 

As you are aware, historically, the Budesbank has been regarded for its model 

independence. Under its charter, the Budesbank does not undertake a supervisory 

function, as the Fed does, and its Chairman can only serve one term. Under Dodd-Frank, 

the Fed has become a monolithic regulator, and I believe that this policymakiugfregulatory 

role stands in clear conflict with the Federal Reserve's function in setting monetary policy. 

Simply put, the Fed has its hands in far too many pots. You could fairly say that the Fed 

now has not a dual mandate, but a triple mandate given its beefed-up supervisory role. 

How many mandates are too many? How can you ensure that Fed's various functions do 

not conflict? 

Like many other central banks around the world, the Federal Reserve participates with other 

agencies in supervising and regulating the banking system. The Federal Reserve's involvement 

in supervision and regulation confers two broad sets of benefits to the country. 

First, the financial crisis has made clear that an effective framework for fmancial supervision and 

regulation must address both safety-and-soundness risks at individual institutions and 

macroprudential risks--that is, risks to the financial system as a whole. All individual fmancial 

institutions that are so large and interconnected that their failure could threaten the functioning of 

the fmancial system must be subject to strong consolidated supervision. Both effective 

consolidated supervision and addressing macroprudential risks require a deep expertise in the 
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areas of macroeconomic forecasting, financial markets, and payments systems. As a result of its 

central banking responsibilities, the Federal Reserve possesses expertise in those areas that is 

unmatched in government and that would be difficult and costly for another agency to replicate. 

Second, the Federal Reserve's participation in the oversight of the banking system significantly 

improves its ability to carry out its central banking functions. Most importantly, the Federal 

Reserve's ability to effectively address actual and potential financial crises depends critically on 

the information, expertise, and powers that it gains by virtue of being both a bank supervisor and 

a central bank. In addition, supervisory information and expertise significantly enhance the 

safety and soundness of the credit the Federal Reserve provides to depository institutions by 

allowing the Federal Reserve to independently evaluate the financial condition of institutions that 

want to borrow from the discount window as well as the quality and value of the collateral 

pledged by such institutions. Finally, its supervisory activities provide the Federal Reserve 

information about the current state of the economy and the financial system that, particularly 

during periods of financial crisis, is valuable in aiding the Federal Reserve to determine the 

appropriate stance of monetary policy. These benefits of the Federal Reserve's supervisory role 

proved particularly important during the financial crisis that emerged in 2007. 

In addition, international developments suggest that a central-bank role in supervision can be 

important. For example, many have suggested that the problems with Northern Rock in the 

United Kingdom were compounded by a lack of clarity regarding the distribution of powers, 

responsibilities, and information among the Bank of England, the U.K. Financial Services 

Authority, and the U.K. Treasury. In response, the Bank of England was given statutory 

responsibilities in the area of financial stability, its powers to collect information from banks 

were augmented, and many have called for it to be given increased supervisory authority. In the 

European Union, a new European Systemic Risk Board is being established under which national 

central banks and the European Central Bank will playa central role in efforts to protect the 

financial system from systemic risk. More broadly, in most industrial countries today the central 

bank has substantial bank supervisory authorities, is responsible for broad financial stability, or 

both. 

Further development of these ideas is provided in "The Public Policy Case for a Role for the 

Federal Reserve in Bank Supervision and Regulation," a white paper produced by the Board in 

January 20 I 0 and available at http://www.federalreserve.govlboarddocs!rptcongress!supervision 

!supervision Jeport.pdf. 
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Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System, from Representative Maloney: 

1. Close to 450,000 mes were reviewed by tbe independent consultants in connection with 

the independent foreclosure review. Please indicate how many of those mes were of New 

York Residents. 

The Independent Foreclosure Review ("IFR") required by the regulators' enforcement orders 

against the major mortgage loan servicers included a borrower outreach procedure that allowed 

borrowers who were in foreclosure during 2009 and 2010 at the covered servicers to submit a 

request to have their foreclosure reviewed by an independent consultant. As of December 31, 

2012, the deadline for submission of requests for review, about 500,000 borrowers out of the 

total eligible population of over 4.2 million had submitted requests for review. In addition, at 

Federal Reserve-regulated servicers, approximately 60,000 files were slated for review as part of 

the separate review of certain types of borrower files by independent consultants that was part of 

the IFR - the "look-back." Data for the files slated for review as part of the "look-back" was not 

maintained on a state-by-state basis. 

As you know, the IFR ceased at the 13 servicers participating in the agreement in principle 

announced by the Federal Reserve and Office ofthe Comptroller of the Currency ("OCC") in 

January. As a result of the agreement, each of those 4.2 million borrowers will receive some 

direct compensation and may benefit from additional assistance that we are requiring from the 

servicers, including all eligible borrowers from New York, regardless of whether their file would 

be reviewed as part of the IFR. 

2. There are still 4 million borrowers who were in foreclosure between 2009 and 2010. 

With an $8 billion settlement, how far do you believe it will go? Will the payment match 

the harm? 

With the OCC taking the lead, we undertook strong enforcement actions in 2011 to help the 

millions of affected borrowers in foreclosure during 2009 and 20 I 0 and to correct mortgage 

servicing deficiencies. Our goals were, and continue to be, to require the major lenders and 

servicers to correct their foreclosure practices and maintain practices that ensure that no 

consumer is wrongfully foreclosed upon or wrongfully denied access to available loan 

modification programs, and to assist borrowers subject to improperly administered foreclosure 

practices. Our enforcement actions required the servicers to immediately correct foreclosure 

practices. When it became clear that the reviews of individual files to identifY injured borrowers 

required by our enforcement actions - the IFR - would significantly delay getting remediation to 

borrowers, the OCC and the Federal Reserve, after consulting consumer groups, chose to change 

course with respect to that requirement of our enforcement actions. Although none of the 

available options were ideal, we accepted the agreement, which provides some immediate 

assistance to all in-scope borrowers, because that approach will result in money being paid to 

more borrowers in a shorter time frame than would have occurred if the file reviews had 

continued. This approach also preserved the rights of borrowers to obtain full remediation for 

any injury. 
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3. Who gave the order that no money wonld be paid to borrowers while close to $2 billion 

in fees was generated? 

The process of carefully reconstructing and reviewing the hundreds of thousands of files to 

ensure consistent treatment took the servicers and independent consultants substantial time and 

required significant resources. As the IFR proceeded, it became clear that the process of 

identifying injured borrowers and determining the type and amount of remediation due them was 

proceeding much too slowly, largely due to this complex and labor-intensive process. The 

regulators, after consulting with community groups, chose to change course. Although none of 

the available options were ideal, we accepted the agreements to pay all in-scope borrowers and 

provide other foreclosure prevention assistance because that approach will result in money being 

paid to more borrowers in a shorter time frame than would have occurred if the file reviews had 

continued. 

4. We have been told that there was agreement that institntions wonld not compensate 

injured borrowers until all institntions were ready to do so. 

a. Were you aware ofthis agreement? 

Please see response for 4 (c). 

b. Do yon believe it was appropriate to allow the process to be conducted in that 

manner? 

Please see response for 4 (c). 

c. Wouldn't it have been more effective to compensate borrowers where harm 

was found and documented rather than wait for the entire process to be 

completed? 

We are not aware of any such agreement and, in fact, encouraged institutions subject to the 

Federal Reserve's jurisdiction to make payments to borrowers as soon as practicable. The IFR 

required the identification of injured borrowers by the independent consultants and then the 

submission by the servicer of an acceptable plan to provide remediation to those borrowers. 

Processes were being developed to assure that all borrowers who suffered similar financial 

injuries were treated consistently in the remediation they received. The Federal Reserve 

contemplated that, once an institution's remediation plan was completed, we would have 

required the servicer to carry out the remediation without regard to whether other institutions 

were ready to provide remediation. 

5. Please shed some light on the decision to halt the independent review. Were there 

specific reports from the Ie's that led you to believe you weren't going to find what you 

expected to find? 

As noted above, as the IFR proceeded, it became clear that the process of identifying injured 

borrowers and determining the type and amount of remediation due them was proceeding much 
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too slowly, Jargely due to its complex and labor-intensive nature. The regulators, after 

consulting with community groups, chose to change course. Although none of the available 

options were ideal, we accepted the agreements to pay all in-scope borrowers and provide other 

foreclosure prevention assistance because that approach will result in money being paid to more 

borrowers in a shorter time frame than would have occurred if the file reviews had continued. 

6. Do you believe that injured borrowers will be rightly compensated for the financial 

harm they suffered? 

Please see response to question 2. 

7. How have practices at the institutions that you supervise changed since the consent 

orders were signed? 

The provisions of the Federal Reserve's mortgage servicing-related Consent Orders required 

servicers to fix what was broken to ensure a fair and orderly mortgage servicing process going 

forward, and the Federal Reserve continues to expect servicers to fully correct these practices 

and policies. In the time since issuing our orders, progress has been made in implementing better 

controls, and improving systems and processes designed to ensure the errors leading to our 

enforcement actions do not recur. The Federal Reserve is examining servicers to monitor and 

test these improvements and examiners will continue to work to ensure complete compliance 

with the Federal Reserve's enforcement actions and to verifY the corrective actions taken by the 

servicers. In addition we are coordinating very closely with the Consumer Financial Protection 

Bureau ("CFPB") on the implementation of standards that help improve mortgage servicing 

across the industry. 

8. Please provide information about how the fee structures between the Ie's and the 

financial institutions were determined and what role the Federal Reserve played in that 

determination, as well as whether the resulting total had any impact on the final figure that 

was agreed to on January 7. 

The independent consultants were retained by the servicers and work for the servicers, subject to 

the oversight of the Federal Reserve and OCC. Accordingly, the fee arrangements between the 

independent consultants and the servicers were negotiated by those parties. Consistent with our 

standard practice, the Federal Reserve did not participate in those negotiations. The Federal 

Reserve reviewed each consultant to a servicer we regulate to ensure that the consultant would 

not be reviewing any work product that the consultant had previously provided to the servicer 

and to ensure that the consultant would be able to review borrower files without influence by the 

servicer that retained them. 

9. There have been concerns expressed that outreach efforts to borrowers by lenders about 

available restitution and a suggestion that efforts were inadequate. Specifically, I would 

like to know what efforts will be made to contact the 5% of the 4.2 million borrowers who 

were not reached with the initial mailing? 
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Serviceable addresses exist for the vast majority of the in-scope population as many borrowers 

have existing relationships with the servicers or their addresses have been identified through 

other means. The regulators have required substantial efforts to locate current addresses for the 

remaining borrowers. These efforts included several rounds of address searches using the 

national change of address database and third-party consumer databases, which contain 

infonnation from sources such as credit bureaus, public records/registrations, utilities, phone 

number databases, and similar sources, to detennine borrowers' most likely current address. 

Borrowers can continue to update contact infonnation with Rust Consulting, Inc. ("Rust"), the 

IFR Administrator and paying agent under the agreement in principle, by calling 1-888-952-

9105. Finally, the paying agent will also take additional steps to identify current addresses for 

borrowers eligible for payment under the payment agreement. There are no additional steps that 

eligible borrowers will need to take to receive payment under the payment agreement. 

10. While the settlement is national in scope, no state was impacted as severely as New 

York with robo-signing, document forgeries and other foreclosure abuses; which has been 

well documented. Accordingly, I hope you will be able to inform me how cases of New 

York borrowers will be reviewed and administered? 

As a result of the payment agreement, approximately 4.2 million "in-scope" borrowers at the 13 

participating servicers, including all eligible borrowers from New York State, will receive some 

monetary compensation. On April 12, 2013, payments began to these borrowers. Payments will 

range from $300 to $125,000 plus equity. As of May 20, 2013, more than 2.4 million checks 

have been cashed or deposited totaling more than $2.2 billion dollars. 

11. Finally, I am hoping you can let me know the criteria that will be used to determine 

how much each individual borrower will be eligible to receive. While I support your desire 

to move forward and offer restitution to injured borrowers, I am hopeful that will be done 

in a methodical manner. 

As noted in the answer to question 10, on April 12, 2013, payments under the payment 

agreement began to the 4.2 million borrowers and as of May 20, 2013, more than 2.4 million 

checks have been cashed or deposited totaling more than $2.2 billion dollars. Payments will 

range from $300 to $125,000 plus equity. In order to detennine the individual payment amounts, 

borrowers were categorized according to the stage of their foreclosure process and the type of 

possible servicer error. Regulators then detennined amounts for each category using the 

fmancial remediation matrix published in June 2012 as a guide, incorporating input from 

consumer groups. The Federal Reserve has published the payment amounts and the number of 

people in each category on its website at http://www.federalreserve.gov/consumerinfo/ 

independent-forec!osure-review-payment-agreement.htm. 

12. Since signing the consent order, how many borrowers in New York state have had their 

files reviewed, and what were the results of those reviews? 

The Federal Reserve has made available on our website data on the number of borrowers who 

have submitted a request to have their mortgage reviewed by an independent consultant as part 

of the IFR. As noted above, the payment agreement replaces the IFR at the 13 participating 
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servicers with a broader framework that allows all borrowers covered by the agreementwhether or not their file was slated for review as part of the IFR - to receive compensation 

significantly more quickly than under the IFR. As a result of the recent agreement, servicers 

must provide monetary compensation to all borrowers within the scope of the original 

enforcement actions; borrower files will no longer be subject to individual review as part of this 

process. 

13. What efforts have been made to find borrowers that have not yet been contacted or 

those who have not responded to mail or telephone attempts, and how many of those are 

estimated to live in New York? 

Please see response to question 9. The Federal Reserve does not have data on a state-by-state 

basis on the number of in-scope borrowers who were not able to be contacted in connection with 

the IFR. 

14. What assurances will borrowers have that any information they provide to servicers 

will not be used in the foreclosure process? 

The Federal Reserve and the OCC have directed servicers to use contact or personal information 

provided in cormection with the IFR only for purposes relating to the IFR process. The privacy 

policy governing the IFR, which remains in effect following the payment agreement, is available 

online on the IndependentForeclosureReview.com website under the privacy policy section. 

15. What assurances will New York state borrowers have under the new settlement that 

they will not be dual tracked with a foreclosure proceeding while the claim is being 

pursued? 

While the payment agreement with the participating servicers itself does not automatically 

forestall or prevent foreclosure actions from continuing, the Consent Orders entered into by the 

servicers expressly address efforts to prevent dual tracking, for example, by requiring servicers 

to improve coordination between their foreclosure activities and their loss mitigation efforts in 

order to prevent unnecessary foreclosures and keep borrowers in their homes whenever possible. 

In addition, the Federal Reserve and the OCC have issued guidance to the servicers subject to the 

Consent Orders directing a review before foreclosure sales for all pending foreclosures. These 

reviews also help prevent avoidable foreclosures by ensuring that foreclosure-prevention 

alternatives are considered and foreclosure standards are met. In addition, the federal banking 

agencies have been working closely with the CFPB to develop national mortgage servicing 

industry standards that limit a servicer's ability to dual track borrowers. Such industry standards 

were issued in January by the CFPB and become effective in January 2014. The Federal Reserve 

is committed to enforcement of our Consent Orders and of these standards. 
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Ouestions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System, from Representative Mulvaney: 

1. The Congressional Budget Office (CBO) projections offuture interest rates published in 

their report titled "CBO Budget and Economic Outlook Fiscal Years 2013-2023" in tables 

B-1 and B-2 are displayed below. Are the Federal Reserve's projections for future interest 

rates for similar products and time frames consistent with CBO's projections? If the 

Federal Reserve does not agree with the CBO projections, please provide your pr9jections, 

explain the reasons for the difference of opinion, and articulate why the Federal Reserve 

believes its numbers are a better gauge of future interest rates. 

Finally, how will the CBO projected interest rates, and if different, the Federal Reserve's 

projected interest rates, affect or alter the Federal Reserve's exit strategy? What are the 

impacts to the economy ofthe exit strategy using these projected rates? 

The CBO projections of interest rates published in their report titled "CBO Budget and 

Economic Outlook Fiscal Years 2013-2023" in tables B-1 and B-2 are as follows: 

Projections by calendar year: 

10-year Treasury note: 2012: 1.8% 2013: 2.1% 2014: 2.7% 2015: 3.5% 2016: 4.3% 2017: 

5.0% 2018: 5.2% 2019: 5.2% 2020: 5.2% 2021: 5.2% 2022: 5.2% 2023: 5.2% 

3-month Treasury bill: 2012: .1 % 2013: .1 % 2014: .2% 2015: .2% 2016: 1.5% 2017: 3.4% 

2018: 4.0% 2019: 4.0% 2020: 4.0% 2021: 4.0% 2022:4.0% 2023: 4.0% 

Projections by fiscal year: 

10-yearTreasury note: 2012: 1.9% 2013: 1.9% 2014: 2.5% 2015: 3.2% 2016: 4.1% 2017: 

4.9% 2018: 5.2% 2019: 5.2% 2020: 5.2% 2021: 5.2% 2022: 5.2% 2023: 5.2% 

3-month Treasury bill: 2012: .1 % 2013: .1% 2014: .1 % 2015: .2% 2016: 1.0% 2017: 2.9% 

2018: 4.0% 2019: 4.0% 2020: 4.0% 2021: 4.0% 2022: 4.0% 2023: 4.0% 

The Federal Reserve does not publish official forecasts of interest rates, in part because the level 

of rates now and in the future is influenced by Federal Reserve policy actions that have not yet 

been decided upon. That said, FOMC participants--the seven Federal Reserve Board governors 

and 12 Reserve Bank presidents--prepare individual economic projections four times each year. 

As part of those projections, FOMC participants project a path for the federal funds rate based on 

their own evaluation of the economic outlook and judgment regarding the appropriate path of 

monetary policy. That information is published as an addendum to the FOMC minutes. The 

most recent projections were prepared for the June FOMC meeting and are available at 

[hrtp:llwww.federalreserve.gov/monetarypolicy/files/fomcprojtabI20 130619.pdf]. Although the 

individual projections vary, the central tendency of these projections for the path of the federal 

funds rate is qualitatively similar to the path shown above for the CBO projections of the threemonth bill rate. In particular, most FOMC participants expect the funds rate to remain quite low 

through 2015. 
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The trajectory for the path of short-tenn interest rates has implications for longer-tenn yields. 

Specifically, longer-tenn yields will tend to move higher as investors perceive that the date after 

which the FOMC is expected to begin raising short-tenn rates is drawing closer. This effect is 

evident in the CBO projections for the ten-year Treasury yield; it begins to move higher in 2013 

and 2014 even though the CBO projects the three-month bill rate to remain quite low throughout 

2015. In addition to this effect operating through expectations regarding short -tenn rates, the 

nonnalization of the size of the Federal Reserve's balance sheet should put some additional 

upward pressure on long-tenn rates by raising the tenn premiums embedded in yields on longtenn securities. 

In short, in most economic forecasts, short and long-tenn rates rise gradually over time as the 

economy continues to recover. A discussion of this and related issues is included in a recent 

speech by Chainnan Bemanke entitled "Long-Tenn Interest Rates" and available at 

http://www.federalreserve.gov/newsevents/speechibemanke20130301a.htm. 

2. In the Subcommittee on Monetary Policy and Trade hearing entitled "Near-Zero Rate, 

Near-Zero Effect? Is 'Unconventional' Monetary Policy Really Working?" on March 5, 

2013, two witnesses, Dr. Joseph Gagnon and Mr. David Malpass, expressed conflicting 

views on the Federal Reserve's ability to influence short-term interest rates during its exit 

from quantitative easing because of a lack of short-term Treasury bills. Dr. Gagnon 

argued that the Federal Reserve could enter into repurchase agreements on its long-term 

securities and have the same effect as selling Treasury bills. Mr. Malpass responded that 

this would not be a viable option because the market for repurchase agreements could not 

sustain the maguitude of repurchase agreements the Fed would need to manipulate the 

short-term interest rate. Does the Fed have the practical ability to manipulate short term 

interest rates through repurchase agreements, and what would be the implication to the 

repo market if the Federal Reserve engaged in this activity? Does the increasing size of the 

Federal Reserve balance sheet reduce the efficacy of using repurchase agreements to affect 

short-term interest rates? 

As discussed in the minutes of its June 2011 meeting, the FOMC will rely primarily on changes 

in the FOMC's target federal funds rate to remove policy accommodation at the appropriate 

time. During the nonnalization process, adjustments in the interest rate on excess reserves and to 

the level of reserves in the banking system will be used to bring the funds rate toward its target. 

The Federal Reserve has developed tools, including tenn deposits and reverse repurchase 

agreements (RPs), that could be used to drain reserves at the appropriate time if necessary. By 

issuing tenn deposits and reverse RPs, the Federal Reserve will be able to reduce the quantity of 

reserves in the banking system as needed. 

Such draining tools may also have a secondary effect by directly putting upward pressure on 

money market rates. For example, conducting three-month tenn reverse RP operations will drain 

reserves and put upward pressure on the overnight federal funds rate, but such operations will 
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also put some upward pressure on the three-month term RP rate. The extent of the latter effect is 

difficult to gauge, but would also work in the general direction of tightening financial conditions. 

The Federal Reserve can also drain reserves and tighten financial conditions by selling assets, if 

necessary. In short, the FOMe is confident that it has the tools necessary to withdraw policy 

accommodation at the appropriate time. 

3. Chairman Bernanke, in your testimony before the Committee on Financial Services on 

February 7, 2013, you said "Federal Reserve analysis shows that remittances to the 

Treasury could be quite low for a time in some scenarios, particularly if interest rates were 

to rise quickly." In fact, a chart in the January 2013 Federal Reserve staff report 

referenced in your testimony shows that remittances drop to zero as interest rates rise 

when the Federal Reserve continues to make asset purchases to expand its balance sheet 

through 2013, a program it has already begun. What it doesn't show, however, is how 

much the Federal Reserve is losing as interest rates rise. In each ofthe scenarios explored 

in your staff report, and at the current pace of purchasing $85 billion per month of 

securities over 2013, what is the expected profit or loss from your unconventional policy 

measures? In your response, please distinguish between the profit or loss from interest 

paid on reserves and the profit or loss from balance sheet assets. Also, please provide an 

update of how much you have made from quantitative easing to date, how much you expect 

to make, and how much you estimate that you will lose as interest rates rise at the end of 

unwinding the Fed's balance sheet. 

The Federal Reserve has a dual mandate of fostering price stability and maximum employment, 

and the large-scale asset purchases have been undertaken in pursuit of that mandate. Any profits 

or losses from the policy are incidental to the ultimate goals of policy. Indeed, a more rapidly 

growing economy benefits the fiscal position of the federal government substantially more--

through reduced expenditures on unemployment benefits and increased tax receipts--than any 

variation in the Federal Reserve Board's earnings. 

From 2009 through 2012, the Federal Reserve remitted almost $300 billion to the U.S. Treasury, 

an average of over $70 billion per year. Prior to the financial crisis, the Federal Reserve would 

typically remit between $20 and $25 billion to the Treasury per year. 

The staff working paper projects--under a variety of assumptions--how the Federal Reserve's 

income might evolve over coming years. That analysis includes both the possibility of realized 

losses from asset sales as well as the expense of paying interest on reserve balances. In the 

scenarios analyzed, when assessing the effects on Federal Reserve earnings over the entire period 

of asset purchases, the average annual remittances to the Treasury exceeds the typical annual 

remittances prior to the crisis. That averaging combines periods when remittances are 

substantially above historical averages, as they have been since 2009, with periods when 

remittances fall, perhaps to zero. http://www.federalreserve.gov/pubs/feds!2013!201301 

lindex.htmI 
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Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System, from Representative Ross: 

1. Why does the Board continue [to] see things only through a bank-centric, one-sized-fits 

all approach? Can you explain to this committee why you are moving to take away, usurp, 

or simply ignore the authority of state regulators to set minimum capital requiremeuts or 

what purpose it serves? 

Section 171 of the Dodd-Frank Wall Street Refonn and Consumer Protection Act (Dodd-Frank 

Act) requires the Board to establish consolidated minimum risk-based and leverage capital 

requirements for depository institution holding companies, which includes savings and loan 

holding companies with insurance operations, that are "not less than" the minimum capital 

requirements for insured depository institutions. Capital requirements for insurance companies 

are imposed by state insurance laws on a legal entity basis, rather than a consolidated basis. On 

June 7, 2012, the Board and the other federal banking agencies proposed to revise their riskbased and leverage capital requirements in three notices of proposed rulemaking (NPRs), 

consistent with this statutory requirement. 

The NPRs proposed flexibility to address the unique character of insurance companies through 

specific risk weights for policy loans and non-guaranteed separate accounts, which are typically 

held by insurance companies, but not banks. These specific risk weights were designed to apply 

appropriate capital treatments to assets particular to the insurance industry while complying with 

the requirements of section 171 of the Dodd-Frank Act. 

The Board is carefully considering the comments it has received regarding the application of 

section 171 of the Dodd-Frank Act to savings and loan holding companies and bank holding 

companies that are significantly engaged in the insurance business. We will continue to consider 

these issues seriously, as well as the potential implementation challenges for depository 

institution holding companies with insurance operations, as we detennine how to move forward 

with respect to the proposed capital requirements. 

2. I often wonder how much monetary policy is trumped by excessive rules and regulatious 

that impose unnecessary costs and burdens on businesses that provide something as vital as 

homeowners insurance in Florida. As I mentioned, the Board's rule requiring GAAP 

financial filings in addition to SAP filing is going to be costly. Please tell me exactly what 

new, relevant, important information will you [and} the Board glean from these new 

regUlations that will justify the rate increases Florida homeowners could see. 

Section 171 of the Dodd-Frank Act requires the agencies to establish consolidated minimum 

risk-based and leverage capital requirements for depository institution holding companies, 

including savings and loan holding companies, that are no less than the generally applicable 

capital requirements that apply to insured depository institutions under the prompt corrective 

action framework. The "generally applicable" rules use generally accepted accounting principles 

(GAAP) as the basis for regulatory capital calculations. 
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The proposed requirement that savings and loan holding companies calculate their capital 

standards on a consolidated basis using a framework that is based on GAAP standards complies 

with section 171 of the Dodd-Frank Act and would facilitate comparability across institutions. 

In contrast, the statutory accounting principles (SAP) framework for insurance companies is a 

legal entity-based framework and does not provide consolidated financial statements. 

The Board received many comments on the proposed application of consolidated capital 

requirements to savings and loan holding companies, including on cost and burden 

considerations for those firms that currently prepare financial statements based solely on SAP. 

The Board will consider these comments carefully in determining how to apply regulatory 

capital requirements to bank holding companies and savings and loan holding companies with 

insurance operations consistent with section 171 of the Dodd-Frank Act. 

3. Since I was not on the committee during the passage of Dodd-Frank, could you speak to 

your logic behind the development of this rule since much of it was not part of the Collins 

Amendment and could be in direct conflict of McCarran-Ferguson? 

As discussed above, the agencies proposed revisions to the regulatory capital rules consistent 

with various provisions of the Dodd-Frank Act, including section 171, which requires the Board 

to establish consolidated minimum risk-based and leverage capital requirements for depository 

institution holding companies that are not less than tlle generally applicable capital requirements 

that apply to insured depository institutions. This requirement applies to all depository 

institution holding companies, including savings and loan holding companies primarily engaged 

in the insurance business. 1 

The Board has received some comment letters that discuss the McCarran-Ferguson Act and will 

take these comments into consideration. 

4. Lastly, do you believe that if these rules were in place, they would have prevented the 

AlG collapse? 

While it is difficult to say with certainty whether the proposed rules would have prevented the 

events at AIG, the proposed rules would have imposed consolidated capital requirements on all 

savings and loan holding companies, including AIG, that were not in place in the period leading 

up to the crisis. The risk measurement and reporting requirements associated with the 

consolidated regulatory capital requirements that would have been in place, had the proposed 

rules been applicable to AIG at the holding company level several years ago, likely would have 

required AIG to hold significantly more capital against its riskier transactions and possibly 

constrained its behavior. They also would have provided a basis for consolidated supervision of 

the company's capital adequacy and may have allowed supervisors to identifY and address some 

of the riskier activities undertaken by certain entities within the AIG structure. 

I See 15 U.s.C. 5371(a)(3) and (b)(I), (b)(2). 
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Questions for The Honorable Ben Bernanke, Chairman, Board of Governors of the Federal 

Reserve Svstem, from Representative Royce: 

Entitlements and Long-Term Fiscal Concerns 

1. During the recent hearings in the House in Senate, Mr. Chairman, you heard a number 

of concerns expressed regarding our fiscal position and the national debt. You repeatedly 

stated that we need to make changes in the long-run or long-term. My question, 

Mr. Chairman, is when does the long-run end? Or to use your words from the Senate 

hearing, when do we get to "the point where the debt really begins to explode?" Would you 

agree it is mathematically impossible to keep tax revenue at its historical average and not 

address entitlements without an explosion of deficits? 

Fiscal policymakers confront daunting challenges, and the economy's performance will depend 

importantly on the choices that are made about the course of fiscal policy. I believe that fiscal 

policymakers should keep three objectives in mind as they face these decisions. First, to 

promote economic growth and stability, the federal budget must be put on a sustainable long-run 

path that first stabilizes the ratio of federal debt to GDP, and, given the current elevated level of 

debt, eventually places that ratio on a downward trajectory. Second, as fiscal policymakers 

address the urgent issue oflonger-run fiscal sustainability, they should avoid unnecessarily 

impeding the current economic recovery. Third, policymakers should make these policy 

adjustments with an eye toward tax and spending policies that increase incentives to work and 

save, encourage investments in workforce skills, advance private capital formation, promote 

research and development, and provide necessary and productive public irrfrastructure. 

Under current CBO projections, the ratio of federal debt to GDP remains near current levels over 

the next five years and then begins to rise over the final five years of the projection, and based on 

their longer term outlook, debt mounts rapidly after 2023 owing to the effects of population 

aging and the continued rise in health care costs. In CBO's scenario, taxes are near their longterm average and non-interest outlays rise well above their long-run average and thus deficits 

widen. It is critical that policymakers address these long run imbalances between spending and 

taxes by lowering the trajectory for outlays, raising taxes above their long-run average, or some 

combination of the two. A credible fiscal plan that addresses these longer-run challenges could 

help keep longer-term interest rates low and boost household and business confidence, thereby 

supporting economic growth today. 

Contradictory Impact of Quantitative Easing (QE) on Growth 

2. Chairman Bernanke; despite the Federal Reserve's $3 Trillion -and growing- balance 

sheet today, isn't the real effect of quantitative easing at this point in our economic cycle, 

after the crisis, contradictory with respect to real growth and job creation, despite an 

accommodative monetary policy? 

The Federal Reserve and many other central banks around the world are expanding their 

balance sheets to the favor of government, housing finance, and big banks, yet growth is 

marginal and jobs aren't being created fast enough by new ventures and small businesses. 
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Isn't the impact of QE to reallocate credit to the government and housing without 

expanding it in other parts of the private sector where it is needed? Is the central bank's 

traditional transmission mechanism broken and having a negative impact, instead of its 

intended beneficial impact? If it isn't broken after four years of unprecedented monetary 

policy accommodation, then why is growth so low and job creation not growing faster? 

The U.S. economy continues to face headwinds; these include not only the tax increases and cuts 

in government spending enacted earlier this year, but also still-tight credit conditions for many 

small businesses and for households that have less-than-pristine credit records. While monetary 

policy cannot fully offset these headwinds, there is substantial evidence that the Federal 

Reserve's monetary policy--including its purchases oflonger-term securities--have reduced 

interest rates, helped improve financial conditions more broadly, and contributed to growth of 

economic activity and employment. Low interest rates have boosted private demand for goods 

and services, giving businesses a reason to expand production and create jobs. Low mortgage 

rates are helping to strengthen the housing market, contributing to rising sales and construction 

of new homes, and to increased employment of construction workers, many of whom work for 

small businesses. Low interest rates also have contributed to rising home prices, putting more 

homeowners in a position to refinance and benefit from lower mortgage payments. Low rates for 

car loans have spurred sales of motor vehicles and thus raised employment in the U.S. auto 

industry. While the purpose of our monetary policy is to promote maximum employment and 

price stability, it also has helped improve the health of the banking system; the combination of a 

stronger banking system and a stronger economy has increased the amount of credit flowing to 

American households and businesses, helping to support the economic recovery. 

Ad Hoc Monetary Policy 

3. Mr. Chairman, businesses and investors are increasingly interested in when the Fed will 

begin to raise rates. Which indicator is relevant for these businesses and investors today? 

Is it through mid-2015 as announced last September and reflected in the FOMC's forward 

guidance? Is it as long as unemployment is above 6.5% (and inflation below 2.5%) as 

announced in December? Or should investors be focused on the rule Fed Vice Chairman 

Janet Yellen believes should be followed in normal times, which suggests rates should begin 

to rise before 2015? 

In its most recent statement, the Federal Open Market Committee indicated that the current 

exceptionally low level of short-term interest rates will be appropriate at least as long as the 

unemployment rate remains above 6-112 percent, inflation between one and two years ahead is 

projected to be no more than a half percentage point above the Committee's 2 percent longer-run 

goal, and longer-term inflation expectations continue to be well anchored. As you note, this 

quantitative approach to describing its policy outlook replaced the date-based guidance that the 

Committee had employed until last fall. Under the date-based guidance, the Committee had 

indicated that it anticipated that economic conditions would warrant exceptionally low levels of 

interest rates at least through mid-20l5. It is worth noting, however, that the Committee, in its 

December statement indicated that the new quantitative thresholds were consistent with the 
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earlier date-based guidance. With regard to the economic indicators that would be relevant for 

businesses and households in evaluating the likely stance of monetary policy going forward, the 

Committee has indicated that in addition to the unemployment and inflation rates, it considers 

other information, including additional measures oflabor market conditions, indicators of 

inflation pressures and inflation expectations, and readings on financial developments. 

TBTF fixed globally? 

4. Last week, Governor Tarullo presented a paper at Cornell law school on the 

international cooperation in financial regulation, which arguably is a good thing given the 

global impact of financial crises in modern times. Yet, how can we say we have solved the 

policy of "too big to fail"-TBTF) and are enhancing financial stability, especially if there is 

no binding mechanism in place today for the cross-border resolution of large failing, 

globally active banks or means for cross-border dispute resolution? The Financial 

Stability Board's recommended principles from 2012 are nice to have, but have no legally 

binding impact on the United States or any other G20 nation. 

David Wright, the Secretary General of IOSCO, late last year, reviewed the case for a 

binding international agreement or treaty - such as we have in other policy areas like trade 

(WTO), health (WHO), or airplane safety - for things like the cross-border resolution of 

large failing global banks. Until we have some kind of treaty or agreement in place, even if 

limited to cross-border resolution and dispute settlement, how can we convincingly say that 

we truly have ended TBTF under either the bankruptcy code or Dodd-Frank and thereby 

enhanced financial stability? 

The Dodd-Frank Act provides a number of tools that did not exist prior to the recent fmancial 

crisis to address the too-big-to-fail problem. These include: 

• providing for an orderly resolution process for systemically significant non-bank fmancial 

institutions; 

• requiring living wills to help guide institutions and regulators to improve resolvability of 

significant financial firms; 

• requiring enhanced prudential supervision and capital requirements for large, systemically 

significant financial firms; 

• bringing previously unregulated, systemically-important financial entities under the 

regulatory umbrella; 

• providing a new financial sector concentration limit and giving the Fed new authority to 

consider financial stability in merger and acquisition proposals by banking firms; and, 

• central clearing of derivatives to help reduce interconnectedness. 
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Although these new statutory tools are in various stages of regulatory implementation, the Fed 

has already strengthened its oversight of large, complex banking firms and has worked with 

these firms to materially improve their capital adequacy and capital planning through our 2009 

SCAP exercise and our annual CCAR exercise since 2011. We have also now released our 

proposals to implement enhanced prudential standards for large U.S. and foreigu banking firnls 

and FSOC-desiguated nonbank firms. The proposed rules, which increase in stringency with the 

systemic footprint of the covered company, would provide incentives for covered companies to 

reduce their systemic footprint and require covered companies to internalize the external costs 

that their failure or distress would impose on the broader financial system. 

In addition, I note that the FDIC's orderly liquidation powers are effective today and their core 

regulatory implementation architecture is in place. More work remains to be done around the 

world to maximize the prospects for an orderly SIFI resolution, but the basic framework is in 

place in the United States. 

We have made significant progress towards eliminating too big to fail, and ratings actions taken 

over the past two years by Moody's with respect to our largest banking firms are a reflection of 

the progress we have made on that front. More work remains to be done, but eliminating too big 

to fail is a core objective as we implement Dodd Frank and Basel 3 reforms. 

Too Much Leverage, Not Enough Capital Formation and Investment 

5. Mr. Chairman, we have a monetary policy (QE) that encourages borrowing by the 

government and housing industry especially based on the Federal Reserve's purchases on 

its balance sheet, and at the same time we have a fiscal policy in this country, through the 

national budget and both corporate and individual tax codes, that also rewards leverage 

(by_ credits and other tax expenditures for borrowing) and penalizes capital formation and 

investment. 

What do we need to do with respect to both monetary policy and fiscal policy to achieve a 

better balance, where capital formation and wealth generation for investment aren't 

penalized and borrowing isn't rewarded as much as it has been historically? On both 

fronts, how [do] we get from where we are today - too highly leveraged a nation - to a 

more responsible position where capital formation and investment in growth and jobs is 

rewarded and not penalized (or demonized)? 

The financial crisis, the deep recession that followed, and the subsequent slow recovery has 

presented substantial challenges for monetary and fiscal policy. For monetary policy, the 

primary challenge has been to accommodate exceptionally weak aggregate demand--which has 

caused employment to fall to an unacceptable level--and stave off an unwelcome disinflation in 

an environmcnt where the eqUilibrium real rate of interest has been historically low. In striving 

to meet this challenge, the Federal Open Market Committee (FOMC) first lowered the target 

federal funds rate to its effective lower bound in latc 2008, then began communicating its 
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intention of holding the federal funds rate at an exceptionally low level as long as 

macroeconomic conditions warrant. It also initiated substantial purchases of longer-term 

government securities to put further downward pressure on market interest rates. These 

monetary policy actions were needed to provide much-needed support to aggregate demand and 

to keep overall price inflation from falling too far below the FOMC's longer-run objective of 

2 percent per year. In part because of monetary policy, U.S. macroeconomic performance and 

labor market conditions have continued to improve gradually, and overall economic activity and 

employment appears likely to continue rising this year and, according to the central tendency 

forecasts produced by the FOMC in March, is expected to accelerate over the next two years. 

Fiscal policy, at all levels of government, also has been and continues to be an important 

determinant of the pace of economic growth. Federal fiscal policy, taking into account 

discretionary actions and so-called automatic stabilizers, was, on net, quite expansionary during 

the recession and early in the recovery. Although near-term fiscal restraint has increased, much 

less has been done to address the federal government's longer-term fiscal imbalances, which, in 

large part, reflect the effects of the projected aging of our population and anticipated increases in 

health care costs, along with mounting debt service payments. To promote economic growth and 

stability in the longer term, it will be essential for fiscal policymakers to put the federal budget 

on a sustainable long-run path. Importantly, the objectives of effectively addressing longer-term 

fiscal imbalances and of minimizing the near-term fiscal headwinds facing the economic 

recovery are not incompatible. To achieve both goals simultaneously, the Congress and the 

Administration could consider replacing some of the near-term fiscal restraint currently in law 

with policies that reduce the federal deficit more gradually in the near term but more 

substantially in the longer run. 

Housing Prices 

6. How do you evaluate the role the Federal Reserve has been playing to provide liquidity 

to the housing market? Some observers suggest that the increase in house prices against 

normal seasonal patterns may be building to another house price bubble down the road. 

Those who believe in a stock valuation model of discounted cash flows approach to house 

prices suggest that the inevitable normalization of rates will deflate house prices as a result 

and thus the current valuation gains are illusory. What do you think the result of the 

normalization of rates will be for equity in homes? 

Recent purchases of agency mortgage-backed securities are one way through which the Federal 

Reserve has sought to provide support to the housing market. These purchases have contributed 

to historically low mortgage interest rates in recent years, which have increased housing 

affordability for homeowners eligible for new mortgages. The Federal Reserve's actions may 

have contributed to the recent increases in house prices, although this connection is not wellestablished and will be a topic of much research in the years to come. Concerns that recent 

increases in house prices are the beginnings of "another housing bubble" ought to be tempered 

by the fact that mortgage credit is tight for all but the highest credit quality households and 

aggregate mortgage debt outstanding continues to contract. 
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As you note, standard pricing models support the notion that rising interest rates will put pressure 

on house prices. The magnitude of the effect is difficult to gauge because of uncertainty over 

how much rates will rise and because the precise relationship between house prices and interest 

rates is not well-established. Many economic models suggest that rising interest rates will lead 

to a deceleration in the pace of house price growth but should not derail the recovery in housing 

markets. Indeed, expectations for a housing market recovery may be justified by relatively low 

price-to-rent ratios as well as by strong pent-up housing demand. 

Cost and Benefits of Dodd-Frank Rules 

7. Mr. Chairman, what is the impact ofthe 400 new Dodd-Frank rules on economic 

growth and job creation? Is the net impact positive or negative in your view? 

!fno one - including the Federal Reserve - has attempted to do it, shouldn't some 

organization take a hard, independent, and objective look at the impact on our financial 

system and our economy? Wouldn't some kind of methodical, regnlar economic impact 

assessment of these new rules be a good thing to know? 

Many of the Dodd-frank Act provisions are still in the early stages of implementation making it 

difficult to accurately assess the impact of the Act at this point. 

Overall, we expect a safer financial system to contribute to higher levels of economic activity 

and employment, on average. Most importantly, it is clear that distress within the fmancial 

system can lead to notable contractions in economic activity and employment, and regulatory 

reform, by reducing the probability of such severe financial strains, should lead to higher levels 

of economic activity and employment. Indeed, analyses of portions of the revised regulatory 

framework - while falling short of a comprehensive analysis of all reforms associated with 

Dodd-Frank and related efforts - suggest such benefits from reform. 

That said, it is difficult to envision an effort to assess the macroeconomic effects of the combined 

set of reforms. Economic models of the macroeconomy typically do not contain the type of 

detailed modeling of the financial system needed to provide such a systematic assessment and 

detailed data are not available regarding many of the macroeconomic effects. In our 

implementation efforts, we consider the economic impact of proposed changes, and engage with 

our fellow regulatory agencies, private-sector groups, consumer advocacy organizations, and the 

broader public to gain as full an understanding as possible of how implementation of DoddFrank reforms will affect the economy. 

Financial Stability Defined 

8. Mr. Chairman, in the Federal Reserve's new role as the chief regulator for financial 

stability purposes under Dodd-Frank, you have issued or will issue uew rules that hinge ou 

the importance of financial stability without really defining what we mean - in Dodd-Frank 

for example - by the "financial stability ofthe United States." 
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The Office of Financial Research (OFR) defined "financial stability" in its first annual 

report as: "Financial stability' means that the financial system is operating sufficiently to 

provide its basic functions for the economy even under stress." Is that definition 

subscribed to by the Federal Reserve, yes or no? 

If not, what is yours, and what are the implications for new policies like the FSOC 

designation of nonbank financial institutions as systemically important or the enhanced 

prudential standards in Dodd-Frank Sec. 165, which are still pending? Wouldn't you 

agree that we all need to agree on some basic definitions and their implications, not only for 

financial regulation but also their potential impact on the real economy? Please elaborate. 

In its final rule on nonbank designations, the Council said it will consider a "threat to the 

financial stability of the United States" to exist if there would be an impairment of financial 

intermediation or of financial market functioning that would be sufficiently severe to inflict 

significant damage on the broader economy." The Federal Reserve considers this the relevant 

standard for designations. 

FSOC Process 

9. Please update us on how the FSOC and the Fed through your representation on the 

FSOC is approaching the analysis of firms being considered for nonbank SIFI designation. 

Are different metrics being applied in the evaluation of different business models? Are 

those metrics being applied in a consistent manner across all business models (i.e. asset 

managers, insurers, broker dealers, etc)? 

What do you generally believe the timeframe is for the first nonbank SIFI designations to 

occur? 

Will designations occur before prudential standards are established for nonbank SIFls? If 

so, designated firms would face uncertainty, why not wait for rules to be in place before 

designations are made? 

In September of last year, the GAO issued a report that contained specific 

recommendations to strengthen the accountability and transparency of FSOC and OFR's 

decisions and activities as well as to enhance collaboration among FSOC members and with 

external stakeholders. I ask that you submit a statement for the record that details the 

progress made with respect to each of the recommendations. 

The report also suggested working to rationalize rulemakings and using professional and 

technical advisors including state regnlators, industry experts and academics to assist 

FSOC. What has been done in this regard? 
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In considering which nonbank financial firms should be assessed for potential designation as 

systemically important, the Council is using a combination of quantitative and qualitative metrics 

that facilitate comparative analysis across firms while also considering the unique factors 

specific to a firm and its industry. In laying out this approach, the Council issued a final rule and 

interpretive guidance that describes a three-stage process leading to a proposed determination. 

The first stage applies uniform quantitative thresholds, the second stage analyses identified firms 

based primarily on existing public and regulatory information, using industry- and companyspecific quantitative and qualitative information, and the third stage entails contacting nonbank 

financial companies that merit further review to collect firm-specific information that was not 

available in the second stage. 

The Council has made significant progress in its designation work since finalizing its rule and 

guidance -- particularly by advancing an initial set of companies to the third and final stage of 

the designations process starting in September oflast year. The Council staff are currently 

undertaking a detailed analysis of each company, and providing the companies opportunities to 

provide information regarding their businesses and operations. It is critically important that we 

take the time to get the analysis right, and staff is moving as quickly as possible in doing so. 

Various rulemakings under Dodd-Frank are being conducted by the regulators at the same time 

as the Council's designations process. The Council's ongoing collaboration with regulators, 

including the Federal Reserve, will foster consistency between the designations process and 

those rules. The Council does not believe it is necessary or appropriate to postpone the 

evaluation of companies for potential designation until these other regulatory actions are 

completed. These rulemakings are not essential to the Council's consideration of whether a 

nonbank financial company could pose a threat to U.S. financial stability. 

Regarding the GAO report, in November 2012, the Council and the OFRjointly provided a 

response to Congress and the GAO with a description of the actions planned and taken in 

response to each of the recommendations in the report. Since the GAO issued its report, the 

Council and the OFR have further leveraged outside expertise in several ways. Most notably, in 

November 2012, Treasury announced the members ofa new Financial Research Advisory 

Committee, which will work with the OFR to develop and employ best practices for data 

management, data standards, and research methodologies. The comrnittee is made up of 30 

distinguished professionals in economics, finance, financial services, data management, risk 

management, and information technology. Members include two Nobel laureates in economics; 

leaders in business and nonprofit fields; and prominent researchers at major universities and 

think tanks. The committee held its inaugural meeting in December 2012 in Washington, D.C., 

and has been active through subcommittees that are focused on research, data, technology, risk 

management, and other issues. In addition, through the OFR's ongoing work and symposia, the 

Council is able to draw on the insights and expertise of various industry experts and academics 

on cutting edge systemic risk and financial stability analyses and methods. 
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Section 165 Rules for Foreign Banks with US Operations 

10. In your open meeting to propose the Section 165 rules for foreign banks with U.S. 

operations, the Federal Reserve staff indicated that there was little chance of retaliation 

against U.S. firms based on this proposal. Recently in a speech, EU Commissioner Barnier 

seemed to articulate a strong contradictory view. 

a. Do you still feel there is little chance of similar constraints being put on U.S. firms in 

foreign markets? 

The Board is carefully considering the potential that its action might affect the environment for 

U.S. banking organizations operating overseas. U.S. banking organizations already operate in a 

number of overseas markets that apply Basel risk-based capital requirements to their local 

commercial banking and investment banking activities. In addition, the U.K., which is host to 

substantial operations of U.S. banking organizations, applies local liquidity standards to 

commercial banking and investment banking subsidiaries of non-U.K. banks operating in their 

market. 

b. Will you take in to account this possibility of retaliation when considering changes to the 

rule? 

Please see previous response. 

c. Congress at different times has established express statutory authority for the Fed to 

supervise bank holding companies and also intermediate holding companies for the 

financial activities of commercial firms. Can you please identify the express statutory 

authority for establishing the intermediate holding company structure for foreign banks? 

Title I of the Dodd-Frank Act requires the Board to impose enhanced prudential standards on 

banking organizations, including foreign banking organizations, with $50 billion or more in total 

consolidated assets. Section 165 contains certain required standards and also gives the Board 

authority to adopt additional standards it considers appropriate. 1 Section 168 grants the Board 

specific rulemaking authority to implement subtitles A and C of Title I of the Dodd-Frank Act. 

The Board also is authorized by the Bank Holding Company Act, the Federal Deposit Insurance 

Act, and the International Banking Act to ensure that bank holding companies and foreign 

banking organizations operating in the United States conduct their operations in a safe and sound 

manner. The proposal would adopt the U.S. intermediate holding company requirement as an 

additional standard in furtherance of the stated objective of section 165 to "mitigate risks to the 

financial stability of the United States that could arise from the material financial distress or 

failure of ongoing activities, oflarge, interconnected fmancial institutions.,,2 The U.S. 

intermediate holding company requirement would apply risk-based capital requirements, 

leverage limits, and liquidity requirements on the foreign banking organization's U.S. bank and 

1 12 USC. § 5365(b). 

12 U.S.C. § 5365(a)(I). 
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nonbank subsidiaries on a consistent, comprehensive, and consolidated basis in a manner similar 

to those applied to U.S. banking organizations. 
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Questions for The Honorable Ben S. Bernanke, Chairman, Board of Governors of the 

Federal Reserve System, from Representative Stivers: 

1. With all of the recent discussion centering on systemic risk and "Too Big to Fail," do 

you believe U.S. regional banks are a systemic risk? 

The Dodd-Frank Act ("DFA") identified all bank holding companies with assets in excess of$50 

billion as firms that need to be subject to enhanced prudential standards. In implementing the 

requirements of the DFA, the Federal Reserve has proposed the establishment of enhanced 

prudential standards for this entire popUlation of firms, but has proposed to gradate application of 

the enhanced prudential standards so that the firms with a greater systemic footprint face more 

stringent standards. While regional banks are important contributors to economic growth and 

development within certain geographic areas, the risks to broader financial stability posed by 

U.S. regional banking firms are materially less than the financial stability risks posed by the 

largest and most complex U.S. banking firms. 

2. Do you believe the $50 billion asset threshold is the right proxy for determining systemic 

risk? 

a. Wouldn't the ll-point Test in Title 1 of the Dodd-Frank Act for non-bank systemically 

important financial institutions (SIFls) be a better way to determine bank SIFIs? 

Determining whether a financial institution poses systemic risk requires a complex assessment. 

In designating a nonbank financial company as systemically important, the Dodd-Frank Act 

requires the Financial Stability Oversight Council ("FSOC") to consider: (1) the extent of the 

company's leverage; (2) the extent and nature of the company's off-balance-sheet exposures; 

(3) the extent and nature of the transactions and relationships between the company and other 

significant nonbank financial companies and significant bank holding companies; (4) the 

importance of the company as a source of credit for households, business, and State and local 

govermnents and as a source ofliquidity for the U.S. fmancial system; (5) the importance of the 

company as a source of credit for low-income, minority, or underserved cormnunities, and the 

impact that the failure of the company would have on the availability of credit in such 

cormnunities; (6) the extent to which assets are managed rather than owned by the company; (7) 

the nature, scope, size, scale, concentration, interconnectedness, and mix of activities of the 

company; (8) the degree to which the company is already regulated; (9) the amount and nature of 

the company's financial assets; (10) the amount and types ofliabilities of the company; and (11) 

any other risk-related factors that the FSOC deems appropriate. 

By contrast, Title I of the Dodd-Frank Act requires the Board to apply enhanced prudential 

standards to any bank holding company with total consolidated assets of $50 billion or more. 

Because bank holding companies with only $50 billion in consolidated assets may not pose 

systemic risk, the Board expects to use the authority it has under Dodd-Frank to tailor the 

application of the enhanced prudential standards based on systemic risk-related factors such as a 

firm's capital structure, riskiness, complexity, financial activities, and size. 
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b. What are your thoughts on a proposed framework for defining SIFls through factors as 

detailed in a 2009 study by the Cleveland Federal Reserve (attached)? 

The proposed framework would define a systemically important financial institution in terms of 

its size; whether its failure would transmit distress to other fmancial firms; whether its condition 

is highly correlated with that of other financial firms; and whether it is a dominant participant in 

key financial markets or activities. While somewhat more general than the list of considerations 

the FSOC is required to take into account under Title I of the Dodd-Frank Act, the proposed 

framework would likely require an assessment of many of the same issues. It is also noteworthy 

that the financial firms designated as systemically important by FSOC will be disclosed in its 

Annual Report, which is consistent with one of the 2009 study recommendations. 

3. There are recent concerns that the administrative burden from some of the newly 

written rules stemming from the Dodd-Frank Act is going to have a substantial impact on 

regional and community banks that are not systemically important. How do we ensure 

that we don't harm these traditional institutions in our efforts to protect the economy from 

those that are truly systemically important? 

The Federal Reserve recognizes that regional and community banks playa critical role in the 

U.S. economy and, accordingly, has taken a number of steps to reduce the regulatory burden on 

those institutions. For example, the Board has established a subcommittee to focus on 

supervisory approaches to community and regional banks to help ensure that their views on the 

supervisory process are considered. 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. As an additional example, the Board created the 

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 CDIAC, which meets twice a year with the Board. These and other forms of 

outreach are an important means of helping to strike the right balance between promoting safety 

and soundness throughout the banking system and keeping compliance costs for smaller banks as 

low as possible. 

With respect to the changes we will see in the financial regulatory architecture as a result of the 

Dodd-Frank Act and the recent implementation of the Basel III capital framework, it is important 

to emphasize that these reforms are principally directed at our largest, most complex financial 

firms, including nonbanks. Many of the requirements arising from the new Basel III rules--

which establish an integrated regulatory capital framework designed to ensure that U.S. banking 

organizations maintain strong capital positions--will not apply to smaller banks. In fact, most of 

the significant changes from the proposed capital rules that were made in the final version of the 

rules were in response to concerns expressed by smaller banks. For example, the new rules 

maintain current practices on risk weighting residential mortgages and provide community 
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banking organizations the option of maintaining existing standards on the regulatory capital 

treatment of accumulated other comprehensive income and pre-existing trust preferred securities. 

Our aim with these changes was to reduce the burden and complexity of the rules for community 

banks while preserving the benefit of more rigorous capital standards. Indeed, most banking 

organizations with less than $10 billion in assets already meet the higher capital standards, and 

the new rules will help preserve the benefits of stronger capital positions these banks have built 

since the financial crisis. 

Community banking organizations also will not be subject to the Federal Reserve's additional 

enhanced prudential standards that larger banking firms face or will face, such as capital plans, 

stress testing, resolution plans, single-counterparty credit limits, and capital surcharges. 

Furthermore, most of the major systemic risk and prudential provisions of the Dodd-Frank Act--

such as the Volcker Rule, derivatives push-out, derivatives central clearing requirements, and the 

Collins amendment--will have a far smaller impact on community banks than on large banking 

firms. In focusing on the largest, most complex financial firms, the Dodd-Frank Act reforms aim 

to require those firms to account for the costs they impose on the broader fmancial system and 

soak up the implicit subsidy these fums enjoy due to market perceptions of their systemic 

importance, ultimately creating a more level playing field for financial institutions of all sizes. 

4. What is the legal authority for the Federal Reserve to use Quantitative Easing? 

As you know, the Federal Reserve is charged by Congress with promoting the goals of maximum 

employment, stable prices and moderate long-term interest rates. See 12 U.S.c. § 225(a). The 

Federal Reserve works to accomplish these monetary policy goals in part through the conduct of 

open market operations authorized under section 14 of the Federal Reserve Act. See 12 U.S.C. § 

355. Quantitative Easing is the popular term used to refer to the Federal Open Market 

Committee's program for providing monetary policy accommodation to the economy by 

purchasing and holding longer-term Treasury securities and mortgage backed securities 

guaranteed by the Government National Mortgage Association (Ginnie Mae), the Federal 

National Mortgage Association (Farmie Mae) and the Federal Home Loan Mortgage Corporation 

(Freddie Mac). 

Section 14 of the Federal Reserve Act specifically authorizes the Federal Reserve to purchase 

and sell obligations of or guaranteed by the United States or any agency of the United States, 

such as Ginnie Mae, Fannie Mae and Freddie Mac. Purchases of these securities should put 

downward pressure on longer-term interest rates, support mortgage markets, and help to make 

broader financial conditions more accommodative. These financial developments, in tum, 

should help to strengthen the economic recovery and to ensure that inflation, over time, is at the 

rate most consistent with the mandate from the Congress. 

o